** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM10-K**

 

**ý********ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the fiscal year ended January1, 2005**

 

**or**

** **

**o********TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

# ***Commission filenumber 001-16635***

# * *

**National Vision, Inc.**

*(Exactname of registrant as specified in its charter)*

* *
| **Georgia**                                                                                | ** ** | **58-1910859**                           |
|--------------------------------------------------------------------------------------------|------------|------------------------------------------|
| *(State  or other jurisdiction of  incorporation or organization)*                         | * *   | *(I.R.S.  Employer  Identification No.)* |
| * *                                                                                   | * *   | * *                                 |
| ***296  Grayson Highway*****Lawrenceville,  Georgia**                                      | * *   | **30045**                                |
| *(Address  of principal executive offices)*                                                | * *   | *(Zip  Code)*                            |
| * *                                                                                   | * *   | * *                                 |
| *Registrant’s  telephone number, including area code:   **(770) 822-3600***      |
| * *                                                                                   | * *   | * *                                 |
| *Securities registered pursuant to Section 12(b)  of the Act:*                             |
| ***Common  Stock, par value $0.01 per share, with attached Common Stock Purchase Rights*** |
| ***12%  Senior Secured Notes due 2009***                                                   |
| *** ***                                                                               |
| *Securities registered pursuant to Section 12(g)  of the Act:*                             |
| ***None***                                                                                 |

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

Yes ý****No o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Exchange Act Rule12b-2).

Yes o****No ý

 

The aggregate marketvalue of shares of Common Stock held by non-affiliates of the registrant as ofJuly 2, 2004, was approximately $11.0 million based on a closing price of $2.20per share on the American Stock Exchange on such date.  We have deemed all of our executive officersand directors to be affiliates in computing this amount.

 

The number of shares ofCommon Stock of the registrant outstanding as of February 28, 2005, was5,390,929.

 

Indicate by check markwhether the registrant has filed all documents and reports required to be filedby Section 12, 13 or 15(d) of the Securities and Exchange Act of 1934subsequent to the distribution of securities under a plan confirmed by a court.Yes  ýNoo

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

None

 

Cover

 

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**TABLE OFCONTENTS**

 
| PART I   |       |                                                                                        |   |
|----------|------------|---------------------------------------------------------------------------------------------|--------|
| Item     | 1.         | Business                                                                                    |   |
| Item     | 2.         | Properties                                                                                  |   |
| Item     | 3.         | Legal Proceedings                                                                           |   |
| Item     | 4.         | Submission  of Matters to a Vote of Security Holders                                        |   |
|     |       |                                                                                        |   |
| PART II  |       |                                                                                        |   |
| Item     | 5.         | Market  for Registrant’s Common Stock and Related Stockholder Matters                  |   |
| Item     | 6.         | Selected Financial  Data                                                                    |   |
| Item     | 7.         | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
| Item     | 7a.        | Quantitative  and Qualitative Disclosures About Market Risk                                 |   |
| Item     | 8.         | Financial  Statements and Supplementary Data                                                |   |
| Item     | 9.         | Disagreements  on Accounting and Financial Disclosure                                       |   |
| Item     | 9a.        | Controls and  Procedures                                                                    |   |
| Item     | 9b.        | Other Information                                                                           |   |
|     |       |                                                                                        |   |
| PART III |       |                                                                                        |   |
| Item     | 10.        | Directors  and Executive Officers of the Registrant                                         |   |
| Item     | 11.        | Executive  Compensation                                                                     |   |
| Item     | 12.        | Security  Ownership of Certain Beneficial Owners and Management                             |   |
| Item     | 13.        | Certain  Relationships and Related Transactions                                             |   |
| Item     | 14.        | Principal  Accountant Fees and Services                                                     |   |
|     |       |                                                                                        |   |
| PART IV  |       |                                                                                        |   |
| Item     | 15.        | Exhibits  and Financial Statement Schedules                                                 |   |
|     |       | Index  to Consolidated Financial Statements and Schedule                                    |   |
|     |       | Notes to  Consolidated Financial Statements                                                 |   |
|     | Signatures |                                                                                        |
| Ex-10.23 |       | Letter  Agreement between the Company and Fleet Retail Group, Inc.                          |   |
| Ex-10.26 |       | Form  Performance Unit Award                                                                |   |
| Ex-21    |       | Subsidiaries  of the Registrant                                                             |   |
| Ex-23.1  |       | Consent  of Deloitte & Touche LLP                                                       |   |
| Ex-31.1  |       | Section  302 Certification of the CEO                                                       |   |
| Ex-31.2  |       | Section  302 Certification of the CFO                                                       |   |
| Ex-32.1  |       | Section  906 Certifications of the CEO & CFO                                            |   |
|          |            |                                                                                             |        |  |

 

2

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**PART I**

 

In this Annual Report onForm 10-K, “National Vision,” the “Company,” “we,” “us” and “our” mean NationalVision, Inc. and its subsidiaries.

 

Our fiscal year ends onthe Saturday closest to December 31. Throughout this Annual Report on Form 10-K, depending on the context inwhich used, “2004” refers either to January 1, 2005 or the 52-week fiscal yearthen ended, “2003” refers either to January 3, 2004 or the 53-week fiscal yearthen ended, “2002” refers either to December 28, 2002 or the 52-week fiscalyear then ended, “2001” refers either to December 29, 2001 or the 52-weekfiscal year then ended and “2000” refers either to December 30, 2000 or the52-week fiscal year then ended.

 

This Form 10-K containsforward-looking statements regarding our plans, strategies, objectives, beliefsand intentions.  The words “believe”, “anticipate”,“plan”, “expect” and similar expressions are intended to identifyforward-looking statements. Forward-looking statements represent our expectations concerning futureevents.  The actual outcome of the eventsdescribed in these forward-looking statements could differ materially from ourexpectations.  See “Management’sDiscussion and Analysis of Financial Condition and Results of Operations - RiskFactors” for a discussion of the factors and risks that could contribute tosuch potentially material differences.

 

**Item 1.  Business**

 

Unless otherwiseexpressly stated, all information in Item 1 of this annual Report on Form 10-Kis as of January 1, 2005.

 

**Overview**

 

Our primary business isthe operation of 416 retail vision centers in the United States andMexico.  Approximately 96% of our 2004net revenue from continuing operations was derived from these retail visioncenters.  Based on information availableto us through industry publications, we believe we are the fifth largestoperator of retail vision centers in the United States.  However, as described below, our store countbegan declining during the last half of 2002.

 

Our vision centers arelocated inside 339 Wal-Mart stores (including 35 in Mexico), 47 Fred Meyerstores and on 28 U.S. military bases located in the United States or one of itspossessions.  We also operate twofreestanding stores in the United States.

 

Our vision centers sell awide range of optical products including eyeglasses, contact lenses, sunglassesand a variety of optical accessories. Independent optometrists operate their own practices adjacent to orwithin substantially all of our vision centers, providing our customers withconvenient access to eye examinations and contact lens fittings.  We also operate two centralized optical labsand distribution centers.

 

As described in theremainder of this “Overview” section and elsewhere in this Annual Report onForm 10-K, we face two significant challenges. The first of these is an annual contraction of our store count indomestic Wal-Mart stores.  The second isthe restrictive nature of our Senior Subordinated Notes, the mandatoryredemption provisions of which periodically reduce the cash we might otherwisehave available to invest in new optical ventures and certain other provisionsof which may limit our spending on non-optical business ventures.

 

***Leases with Wal-Mart.***  We depend on our domestic Wal-Mart visioncenters for the bulk of our revenues and cash flow.  Our domestic Wal-Mart vision centers accountfor 73% of our total store count at January 1, 2005, and 82% of our net revenuefrom continuing operations for the year then ended.  Our leases with Wal-Mart for domesticlocations have begun to expire in significant numbers.  The lease on each domestic Wal-Mart storeprovides for a nine-year initial term and a three-year renewal term.  No additional renewal options are availableto us.  However, our tenure in anyparticular location will be extended if our vision center is relocated becauseWal-Mart converts such host location to a Supercenter, in which case our leaseterm starts anew from the relocation date. To our knowledge, Wal-Mart is the only other entity operating visioncenters within its domestic stores, and we believe that Wal-Mart typicallyopens its own vision centers in the spaces we vacate.  We believe that Wal-Mart is the secondlargest operator of retail vision centers in the United States.  Wal-Mart has not offered us leases foradditional optical stores or renewals of expiring leases in the UnitedStates.  Since opening our 400th storeinside a domestic Wal-Mart location in 2001, we have, through January 1, 2005,closed 96 such stores.  We expect toclose 33 domestic Wal-Mart locations in 2005 as a result of lease expirations.

 

As a result of ourdeclining number of vision centers in Wal-Mart stores, we devote substantialattention to developing new businesses. We have begun to open freestanding vision centers and we are seeking toexpand our presence on military bases.  Wemay also seek to acquire vision center locations.  During 2004 we also tested the viability of aretail home medical equipment concept by opening two locations inside

 

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domestic Wal-Martstores.  We expect to terminate this testduring 2005.

 

***Senior Subordinated Notes.* **Our 12% Senior Subordinated Notes, whichwere issued when we emerged from bankruptcy in 2001, result in substantialpayments of principal and interest.  Theassociated Note Indenture provides that we make, subject to the terms of theIndenture, mandatory redemptions at par every six months.  The redemptions are based upon a contractualcomputation of cash generated during the period and are subject to our maintaininga minimum $3.0 million consolidated cash balance.  These mandatory redemption requirements maylimit our ability to invest in new optical ventures.  Through February 28, 2005, we have redeemedapproximately $21.4 million of Notes at par. Additionally, we have repurchased, in negotiated or open markettransactions, Notes with a par value of $25.7 million at an aggregate cost ofapproximately $18.6 million.  We hope tocontinue to repurchase Notes from time to time in negotiated or open markettransactions; however, we were able to purchase only small amounts of Notes atdiscounted prices during the fourth quarter of 2004 and do not expect to beable to purchase any significant amount of Notes at a discount to par in theforeseeable future.  As a result of bothmandatory redemption payments and discounted repurchases, we have reduced thisindebtedness by $47.1 million through February 28, 2005.  The Notes mature on March 30, 2009.

 

Certain provisions of theIndenture may also limit our ability to invest in non-optical new businessventures.  One such provision providesthat we may not spend more than $1.0 million in businesses “...which are not thesame, similar or reasonably related to the businesses in which the Company...”was engaged on May 31, 2001.  ThroughFebruary 28, 2005, we made expenditures of $735,000 in connection with our testof the aforementioned retail home medical equipment  (“HME”) concept.  See “Risk Factors - Our pursuit of otherlines of business could be constrained by the terms of our indenture.”

 

***Review of Strategic Alternatives. ***To help address thechallenges described above, in May 2004 our Board of Directors engaged TMCapital Corp. as financial advisors to review our strategic alternatives.  Such strategic alternatives could possiblyinclude a refinancing of the 12% Notes or a more extensive recapitalization, asale of the Company or a controlling interest therein, or a merger with oracquisition of another entity or other entities.  This strategic review is continuing and wehave engaged in extensive discussions and investigation of several of thesealternatives.  There is no assurance thatany transaction will be pursued or, if pursued, consummated.

 

## **History of theCompany**

## ** **

The Company wasincorporated as a Georgia corporation in 1990 under the name National VisionAssociates, Ltd., when we entered into a master license agreement with Wal-MartStores, Inc.  As subsequently amendedthrough 1994, the agreement gave us the right to open 400 vision centers inWal-Mart stores in the United States.  Weopened the 400th such store in 2001.

 

In late 1997, the Companymade a strategic decision to diversify our revenue base through acquisitions inthe freestanding optical market.  InOctober 1997, we acquired Midwest Vision, Inc. with 51 freestanding retailoptical centers in four midwestern states. In July 1998, we acquired Frame-n-Lens Optical, Inc. with 150freestanding vision centers in California and 120 vision centers located withinSam’s Clubs.  In October 1998, weacquired New West Eyeworks, Inc. with 175 retail optical centers in 13 states,including approximately 120 vision centers in freestanding locations and morethan 50 host vision centers in Fred Meyer stores.  Following the acquisitions, we changed ourname to Vista Eyecare, Inc.  To fund theacquisitions, we issued $125 million of Senior Subordinated Notes due 2005bearing interest at 12.75% per annum.

 

Sales shortfalls in thefreestanding stores caused adverse pressure on cash flow and liquidity.  After failing to negotiate an out-of-courtrestructuring with the holders of the then-outstanding Senior SubordinatedNotes, we filed for reorganization under Chapter 11 of the bankruptcy code onApril 5, 2000.

 

During the bankruptcyprocess, we closed or disposed of all of our freestanding stores and closed allof our host vision centers operating in Sam’s Clubs and in Meijer Thrifty Acresstores.  We emerged from the bankruptcyreorganization process on May 31, 2001, as an operator of 503 vision centerslocated in host environments and on military bases.  At that time, we changed our name to NationalVision, Inc.

 

Since the date we emergedfrom bankruptcy, we have opened 28 vision centers (including two freestandingstores that were relocated from nearby Wal-Mart locations at the time ourleases therein expired), and two home medical equipment stores, and we haveclosed 115 vision centers, as follows:

 

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| ** **                   | ** ** | **Retail Vision Centers**          | ** ** | **Retail**                              | ** ** |
|------------------------------|------------|------------------------------------|------------|-----------------------------------------|------------|
| ** **                   | ** ** | **Inside  U.S.  Wal-Mart  Stores** | ** ** | **Inside  Wal-Mart  Stores  in Mexico** | ** ** | **Inside  Fred  Meyer  Stores** | ** ** | **On  U.S.  Military  Bases** | ** ** | **Free-  Standing  Stores** | ** ** | **Total  No. of  Vision  Centers** | ** ** | **Home  Medical  Equipment  Stores** | ** ** |
|                         |       |                               |       |                                    |       |   |   |   |   |   |   |   | ** ** |   |   |
| Store count, May 31, 2001    |       | 398                                |       | 30                                      |       | 55 |   | 20 |   | 0 | ** ** | **503** | ** ** | 0 |   |
| Store openings               |       | 2                                  |       | 7                                       |       | 4 |   | 13 |   | 2 | ** ** | **28** | ** ** | 2 |   |
| Store closings               |       | (96                                | )          | (2                                      | )          | (12 | ) | (5 | ) | 0 | ** ** | **(115** | **)** | 0 |   |
|                         |       |                               |       |                                    |       |   |   |   |   |   |   |   | ** ** |   |   |
| Store count, January 1, 2005 |       | 304                                |       | 35                                      |       | 47 |   | 28 |   | 2 | ** ** | **416** | ** ** | 2 |   |
| Net change during period     |       | (94                                | )          | 5                                       |       | (8 | ) | 8 |   | 2 | ** ** | **(87** | **)** |   |   |

 

Of our 96 Wal-Martlocations that have closed since we emerged from bankruptcy, 13 wereunderperforming stores that we closed prior to lease expiration and eight werestores for which we did not exercise the 3-year renewal option because storeeconomics were not attractive under the higher minimum rent structure in effectduring the renewal period.  All remainingdomestic Wal-Mart store closings were the result of final expiration of thelease and all available extensions or renewal options.

 

All closings of Wal-MartMexico and Fred Meyer stores since May 29, 2001, have been the result of ourearly termination of leases due to poor operating performance at the locations.

 

All military storeclosings have been the result of lease expirations.

 

Weclosed 60 stores in 2004 and these are included in the activity reported in thepreceding table.  Store opening andclosing activity for 2004 only is presented in the following table:

 
| ** **                    | ** ** | **Retail Vision Centers**          | ** ** | **Retail**                              | ** ** |
|-------------------------------|------------|------------------------------------|------------|-----------------------------------------|------------|
| ** **                    | ** ** | **Inside  U.S.  Wal-Mart  Stores** | ** ** | **Inside  Wal-Mart  Stores  in Mexico** | ** ** | **Inside  Fred  Meyer  Stores** | ** ** | **On  U.S.  Military  Bases** | ** ** | **Free-  Standing  Stores** | ** ** | **Total  No. of  Vision  Centers** | ** ** | **Home  Medical  Equipment  Stores** | ** ** |
|                          |       |                               |       |                                    |       |   |   |   |   |   |   |   | ** ** |   |   |
| Store count, January 4, 2004  |       | 359                                |       | 37                                      |       | 47 |   | 25 |   | 0 | ** ** | **468** | ** ** | 0 |   |
| Store openings                |       | 0                                  |       | 0                                       |       | 0 |   | 6 |   | 2 | ** ** | **8** | ** ** | 2 |   |
| Store closings                |       | (55                                | )          | (2                                      | )          | 0 |   | (3 | ) | 0 | ** ** | **(60** | **)** | 0 |   |
|                          |       |                               |       |                                    |       |   |   |   |   |   |   |   | ** ** |   |   |
| Store count, January 1, 2005  |       | 304                                |       | 35                                      |       | 47 |   | 28 |   | 2 | ** ** | **416** | ** ** | 2 |   |
| Net change during fiscal 2004 |       | (55                                | )          | (2                                      | )          | 0 |   | 3 |   | 2 | ** ** | **(52** | **)** |   |   |

 

Of our 55 Wal-Martdomestic locations that closed during 2004, 13 were underperforming stores thatwe closed prior to lease expiration, eight were stores for which we did notexercise the 3-year renewal option and 34 were closed at lease expiration.  We relocated two of the closed Wal-Martvision centers to freestanding locations.

 

We expect to close ourtwo Home Medical Equipment stores during 2005.

 

See “Management’sDiscussion and Analysis of Financial Condition and Results of Operations -Lease Agreements” for additional information regarding our lease agreements anda schedule of lease expiration dates.

 

## **Dependence onDomestic Wal-Mart Vision Centers**

## ** **

As of January 1, 2005, weoperated 304 vision centers in domestic Wal-Mart stores, all of which operatepursuant to a master license agreement (see “Management’s Discussion andAnalysis of Financial Condition and Results of Operations - Lease

 

5

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Agreements”).  These units generated approximately 82% ofour net revenue in 2004.  Further, theaverage profitability of our domestic Wal-Mart vision centers, measured as apercent of sales, is the highest of any of our retail operations.  We therefore depend on Wal-Mart and on ouragreement with them for our continued viability unless and until we develop areplacement business.

 

## **Retail VisionCenter Operations**

## ** **

Our retail vision centersoccupy between 500 and 3,000 square feet, including areas for merchandisedisplay, customer service, and contact lens fitting.  Each vision center maintains inventory ofapproximately 900 eyeglass frames and 450 pairs of contact lenses, along withsunglasses and other optical accessories. Our two optical laboratories deliver prescription eyewear to our visioncenters.  Approximately 63% of our visioncenters have a finishing laboratory, which allows the vision center to provideone-hour service for most single vision prescription lenses.  These vision centers carry inventory ofapproximately 850 pairs of spectacle lenses.

 

Optometrists areimportant to the success of our vision centers. We strive to have an optometrist locate a practice adjacent to or withinmost of our locations.  Theseoptometrists are typically independent from us and, except in California, leasetheir premises from us.  The rent wetypically charge to these optometrists covers both the premises and theequipment which we provide.  Ouragreement with Wal-Mart contemplates that we generally will have an optometriston duty at least 48 hours each week.  Ourrelationships with optometrists are subject to extensive regulation.  (See “Government Regulation” below.)

 

**Our Testof Freestanding Retail Locations**

 

We operate twofreestanding stores which were opened in August 2004 and November 2004.  In both instances, our managers and otherstore associates moved to the new locations from our closed vision centers inthe nearby Wal-Mart, and the independent optometrists that practiced adjacentto the closed vision centers also elected to move their practices to our newlocations.

 

Our twofreestanding vision centers have a larger retail selling area than is typicalof our locations in host environments, and offer a larger selection ofspectacle frames, including more branded merchandise.

 

These twofreestanding stores were opened as a test. We intend to expand the test by opening between 12 and 18 additionalfreestanding stores in 2005.  Ourhistorical strength has been operating stores within host environments.  Operating within a host such as Wal-Martprovides high visibility and customer traffic with below average advertisingand promotional costs.  Our newfreestanding locations were not expected to generate, and have not generated,revenues at the same level that had been achieved when we operated in theWal-Mart nearby.  We also planned tospend, and are spending, more on advertising and promotion for these storesthan has been typical in our host locations. Our plans to expand this test are contingent upon, among other factors,finding appropriate store locations and retaining our store managers and otherassociates.  Further, we may discontinueexpansion of this test at any time if we are unable to maintain targetedrevenue and profitability levels at new locations as we continue to expand theconcept.

 

During the period fromJanuary 1, 2005 through March 21, 2005, we have opened two additionalfreestanding locations and executed leases for two others.

 

## **Managed VisionCare**

## ** **

We believe that managedcare sales are and will remain a significant percent of total optical industrysales.  Under managed vision care plans,members fulfill their eyecare and eyewear needs at either 1) specific locationsdesignated by the plan sponsor or 2) locations outside of the plan’s networkwhere the provider can accept assignment of benefits as an “out-of-network”provider.  Our declining base of visioncenters may adversely affect our ability to compete for managed care contracts.(See “Risk Factors - Our declining base of vision centers in Wal-Mart storescould make it more difficult for us to compete.”) Managed care sales accountedfor approximately 11%, 12% and 11% of our retail sales in 2004, 2003 and 2002,respectively.  We believe that ourmanaged care sales as a percent of our total sales are significantly lower thanindustry averages.

 

## **IntellectualProperty**

## ** **

Our vision centers inWal-Mart are identified as the “Vision Center located in Wal-Mart” in theUnited States and as “Opticas Centro de Vision” in Mexico.  Our vision centers on U.S. military bases areidentified by a variety of names such as “National Vision Optical,” “VisionCenter,” and “Optical Shop.”  Our visioncenters within Fred Meyer operate as “The

 

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Optical Shoppe.”  These names reflect our belief that webenefit more from the customer traffic generated by our hosts than we do fromconsumer recognition of our trade names, and that our customers will return forfuture purchases based on their positive impression of our operations and storeassociates.  We therefore do not engagein significant promotional activity pertaining to our host store names.

 

We operate our two newfreestanding vision centers under the name “Vision Center II.”  We are promoting this brand name to emphasizethe continuity between our closed Wal-Mart locations and our nearby locationsoutside of the Wal-Mart environment.

 

## **Lease Agreements**

## ** **

We have agreementsgoverning our operations in host environments that typically provide forpayments of minimum and percentage rent. See “Management’s Discussion and Analysis of Financial Condition andResults of Operations - Lease Agreements”.

 

## **Purchasing**

## ** **

To improve purchasingefficiencies, we generally attempt to purchase from a limited number ofsuppliers the merchandise, supplies and component parts (spectacle lenses andframes) required for the various products we sell.  We believe, however, that all merchandise,supplies and component parts are available from a large number of suppliers andmanufacturers, and are generally readily available.  Our purchases are generally not made underlong-term contracts.  We believe that theloss of any one supplier or manufacturer would not have a material adverseeffect on our operations.

 

## **Manufacturing andDistribution**

## ** **

We operate two centrallab and distribution facilities that supply substantially all merchandiserequirements of our domestic vision centers. The facilities are located in Lawrenceville, Georgia and St. Cloud,Minnesota.  Our Lawrenceville facilityalso includes our central administrative offices.

 

Our lab and distributionfacilities provide spectacle lenses, frames, finished spectacles, contactlenses, sunglasses, optical supplies and eyewear accessories to our retaillocations.  We use an overnight deliveryservice to ship completed orders and replenishment items to the visioncenters.  The manufacturing and distributionfacilities are interfaced with our management information system.  Raw materials consist of frames and lenseswhich are readily available from multiple vendors.

 

## **GovernmentRegulation**

## ** **

Our business is heavilyregulated by federal, state and local law.

 

We must comply withfederal laws such as the Social Security Act (which applies to ourparticipation in Medicare programs), the Health Insurance Portability andAccountability Act of 1996 (“HIPAA”) (which governs our participation inmanaged care programs), and the Food and Drug Administration Act (whichregulates medical devices such as contact lenses).  We also must comply with the privacy andsecurity regulations under HIPAA.

 

Many states also haveadopted laws that mirror the federal laws described above.  In addition, all states have passed laws thatgovern or affect our arrangements with the optometrists who practice in oradjacent to our vision centers and many states require the presence of licensedopticians during hours when prescription eyewear is being dispensed.  Some states, such as California, Texas, NorthCarolina and Kansas, have particularly extensive and burdensome requirementsthat affect the way we do business.  InCalifornia, optometrists who practice adjacent to our retail locations aresublicensees and contract providers to a subsidiary, which is licensed as aspecialized health care service plan. (See “HMO Operations” below.) Local ordinances (such as zoning requirements) can also imposesignificant burdens and costs of compliance. Frequently, our competitors sit on state and local boards.  Our risks and costs of compliance are oftenincreased as a result.

 

We believe that wesubstantially comply with material regulations that apply to our business.

 

## **Competition**

## ** **

The retail eye careindustry is highly competitive.  Wecompete with large national retailers such as LensCrafters and Pearle.  We also compete with numerous regional andlocal optical chains.  Independentoptometrists, ophthalmologists and opticians often provide many of the samegoods and services we provide.  Inaddition to benefiting from the customer traffic generated

 

7

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by our hosts, we competeon the basis of our competitive pricing policies, product selection, trainingprograms, quality of products and service, and consistency of service.

 

We also compete formanaged care contracts, which can allow us to provide better service to ourmanaged care customers by filing claims directly with the payor and collectingonly the applicable co-pay amount from the customer.  Our declining base of vision centers mayadversely affect our ability to compete for managed care contracts. (See “RiskFactors - Our declining base of vision centers in Wal-Mart stores could make itmore difficult for us to compete.”)

 

Several of ourcompetitors have significantly greater financial resources than we do.  As a result, they are able to advertiseextensively and may be able to engage in extensive and prolonged pricepromotions that may adversely affect our business.    In 2004, our two largest competitorsmerged.  The merger could adverselyaffect our business.  (See “Risk Factors- The retail eyecare industry is extremely competitive.”)

 

**Seasonality**

 

Our vision centers’business is moderately seasonal in a pattern that we believe is alsoexperienced by others in the industry. Generally, our lowest sales volume occurs during our fourth fiscalquarter, when we believe consumers concentrate much of their spending ongeneral and holiday merchandise.  Ourhighest sales volume occurs during our first fiscal quarter, perhaps as thenatural and opposing result of some consumers’ decisions to defer theireye-care expenditures until after the holiday season.  Additionally, individuals who participate inemployer-sponsored healthcare plans may have new funds available for medicalexpenditures at the start of each new year.

 

**HMOOperations**

 

In California, wesell memberships in an eye examination benefit plan and provide eye examinationservices through a wholly owned subsidiary (the “HMO”) that is licensed tooperate as a specialized health care service plan.  This subsidiary’s optometric offices aregenerally located adjacent to retail optical centers inside host retail stores.

 

Prior to 2004, theHMO’s optometric offices were located only in California Wal-Mart stores inwhich we operated a vision center.  The HMO’s leases with Wal-Mart for itsoffices were co-terminus with our leases for the vision center. Therefore, as each of our vision center leases expired, the HMO would close itsoffice in that location.  The HMO operated 93 such offices at the end of2002 and 83 such offices at the end of 2003.

 

During 2004, theHMO began expanding its business by opening and operating offices withincertain California Wal-Mart and Sam’s Club locations in which the vision centerwas operated by Wal-Mart.  In some instances and contrary to its priorpractice, Wal-Mart offered the HMO an opportunity to continue operatingits office in a particular location after we had closed our vision centerin that location.  In other instances, the HMO was offered the opportunityto open an office in a Wal-Mart or Sam’s Club location in which we had notpreviously operated a vision center.  This change allowed the HMO to growin California in 2004, even as we closed another 13 vision center locations dueto lease expiration.  At the end of 2004, the HMO operated 95 optometricexamination offices in California Wal-Mart and Sam’s locations, a net increaseof 12 offices during the year.  Of these 95 offices, 70 are adjacent tovision centers that we operate and 25 are in California Wal-Mart or Sam’slocations in which Wal-Mart operates the vision center.

 

Prior to 2004, theHMO sublet each of its offices to independent optometrists who conducted eyeexaminations in these offices.  The HMOcollected sublicense payments from these doctors in exchange for their use ofthe HMO’s space and examination equipment. During 2004, the HMO began to contract with licensed optometrists toconduct patient eye examinations in some of its offices.  Under this approach the optometrists arecontract employees of the HMO rather than sublicensees.

 

Subsequent toJanuary 1, 2005, and through February 28, 2005, the HMO opened ten additionalCalifornia offices adjacent to vision centers operated by Wal-Mart, increasingits office total to 105, the most it has ever operated.  The HMO expectsto open between 18 and 28 additional new locations during the remainder of2005.

 

**HomeMedical Equipment Stores**

 

In 2004, weopened, as a test, home medical equipment (“HME”) stores inside two domesticWal-Mart locations.  Neither HME storereplaced an existing vision center.  Inthese stores, we sell products such as wheelchairs, scooters, walkers, liftchairs, diabetic shoes and hosiery, bathroom safety equipment and variousorthopedic products.

 

8

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The industryresearch we conducted prior to opening these two stores indicated that newmedical equipment stores require three years to ramp up to stable salesvolumes.  Our operating projectionsassumed net losses for the first twelve months each store operates.  The stores’ results have fallen short ofrevenue projections and operating losses have exceeded projected levels.  We expect to terminate this test during 2005and either close the stores or transfer them to an independent operator.  As a result, we recorded a non-cashimpairment charge of $125,000 in 2004 to write down the value of the long-livedassets at these stores to their fair market value.

 

## **Operations inMexico**

## ** **

Through a wholly ownedsubsidiary, we operate 35 vision centers in Mexico under a master licenseagreement with Wal-Mart de Mexico (see “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations - Lease Agreements”).  Our operations in Mexico face unique risks,such as currency devaluations, inflation and difficulties in cross-culturalmarketing.

 

Information relative tosales and long-lived assets for the United States and Mexico for each of ourthree most recent fiscal years is summarized as follows (amounts in thousands):

 
| ** **                                   | ** ** | **United States** | ** ** | **Mexico** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------|------------|-------------------|------------|------------|------------|------------------|------------|
| 2004:                                        |       |              |       |       |       |             |       |
| Sales from continuing operations during year |       | $                 | 224,455    |       | $          | 4,397            |       | $ | 228,852 |   |
|                                         |       |              |       |       |       |             |       |
| Long-lived assets at end of year             |       | $                 | 97,471     |       | $          | 571              |       | $ | 98,042 |   |
|                                         |       |              |       |       |       |             |       |
| 2003:                                        |       |              |       |       |       |             |       |
| Sales from continuing operations during year |       | $                 | 212,439    |       | $          | 4,275            |       | $ | 216,714 |   |
|                                         |       |              |       |       |       |             |       |
| Long-lived assets at end of year             |       | $                 | 106,065    |       | $          | 833              |       | $ | 106,898 |   |
|                                         |       |              |       |       |       |             |       |
| 2002:                                        |       |              |       |       |       |             |       |
| Sales from continuing operations during year |       | $                 | 192,912    |       | $          | 4,910            |       | $ | 197,822 |   |
|                                         |       |              |       |       |       |             |       |
| Long-lived assets at end of year             |       | $                 | 118,177    |       | $          | 1,204            |       | $ | 119,381 |   |

 

## **Subsequent to January 1, 2005, weclosed four of our vision centers in Mexico. We expect to open one new vision center in Mexico in April 2005.**

## ** **

## **Employees**

## ** **

We employ a total of2,547 associates, 1,913 on a full-time basis and 634 on a part-time basis.  We have 2,062 associates engaged in retailsales, 245 in laboratory and distribution operations, and 240 in management andadministration.  Apart from our retailassociates in Mexico, none of our associates is governed by any collectivebargaining agreements.  We believe ourlabor relations to be satisfactory.

 

## **Our Web Site andAvailability of SEC Reports**

## ** **

Our corporate web site islocated at www.nationalvision.com.  Wemake available on our web site, free of charge and as soon as reasonablypracticable after we file them with the Securities and Exchange Commission (“SEC”),copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q,Current Reports on Form 8-K and any amendments to those reports.

 

These reports may also beobtained from the SEC’s web site, www.sec.gov, or directly from us (withoutcharge) upon written request to National Vision, Inc., 296 Grayson Highway,Lawrenceville, GA 30045, Attn: Investor Relations.

 

9

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**Item 2.  Properties**

 

We own no real estate andoperate solely from leased facilities. The following table presents the number and location of retail visioncenters we operated at the end of each of the last three fiscal years:

 
| ** **             | ** ** | **2002**     | ** ** | **2003**   | ** ** | **2004**     | ** ** |
|------------------------|------------|--------------|------------|------------|------------|--------------|------------|
| ** **             | ** ** | **Inside**   | ** ** | ** ** | ** ** | **Inside**   | ** ** | ** ** | ** ** | **Inside** | ** ** | ** ** | ** ** |
| ** **             | ** ** | **Wal-Mart** | ** ** | ** ** | ** ** | **Wal-Mart** | ** ** | ** ** | ** ** | **Wal-Mart** | ** ** | ** ** | ** ** |
| ** **             | ** ** | **Stores**   | ** ** | **Total**  | ** ** | **Stores**   | ** ** | **Total** | ** ** | **Stores** | ** ** | **Total** | ** ** |
| Domestic:              |       |         |       |       |       |         |       |   |   |   |   |   |   |
| Alabama                |       | 7            |       | 8          |       | 6            |       | 8 |   | 4 |   | 6 |   |
| Alaska                 |       | 3            |       | 13         |       | 3            |       | 11 |   | 3 |   | 11 |   |
| Arizona                |       | 14           |       | 14         |       | 11           |       | 11 |   | 10 |   | 10 |   |
| California             |       | 94           |       | 97         |       | 83           |       | 86 |   | 70 |   | 72 |   |
| Colorado               |       | 8            |       | 8          |       | 8            |       | 8 |   | 8 |   | 8 |   |
| Connecticut            |       | 9            |       | 10         |       | 9            |       | 10 |   | 9 |   | 9 |   |
| Florida                |       | 2            |       | 5          |       | 2            |       | 5 |   | 2 |   | 5 |   |
| Georgia                |       | 36           |       | 37         |       | 34           |       | 36 |   | 28 |   | 30 |   |
| Hawaii                 |       | 4            |       | 4          |       | 4            |       | 4 |   | 4 |   | 4 |   |
| Idaho                  |       | 0            |       | 3          |       | 0            |       | 3 |   | 0 |   | 3 |   |
| Kansas                 |       | 10           |       | 10         |       | 9            |       | 9 |   | 8 |   | 8 |   |
| Kentucky               |       | 1            |       | 1          |       | 1            |       | 1 |   | 0 |   | 0 |   |
| Louisiana              |       | 1            |       | 1          |       | 1            |       | 1 |   | 1 |   | 1 |   |
| Maine                  |       | 0            |       | 1          |       | 0            |       | 1 |   | 0 |   | 1 |   |
| Maryland               |       | 1            |       | 3          |       | 1            |       | 3 |   | 1 |   | 3 |   |
| Massachusetts          |       | 5            |       | 5          |       | 5            |       | 5 |   | 4 |   | 4 |   |
| Minnesota              |       | 1            |       | 1          |       | 0            |       | 0 |   | 0 |   | 0 |   |
| Montana                |       | 2            |       | 2          |       | 2            |       | 2 |   | 2 |   | 2 |   |
| Nevada                 |       | 7            |       | 7          |       | 5            |       | 5 |   | 4 |   | 5 |   |
| New Hampshire          |       | 4            |       | 4          |       | 3            |       | 3 |   | 3 |   | 3 |   |
| New Jersey             |       | 13           |       | 13         |       | 13           |       | 13 |   | 12 |   | 15 |   |
| New Mexico             |       | 10           |       | 10         |       | 10           |       | 10 |   | 9 |   | 9 |   |
| New York               |       | 26           |       | 26         |       | 24           |       | 24 |   | 18 |   | 19 |   |
| North Carolina         |       | 60           |       | 60         |       | 53           |       | 53 |   | 43 |   | 44 |   |
| North Dakota           |       | 4            |       | 4          |       | 0            |       | 0 |   | 0 |   | 0 |   |
| Oregon                 |       | 9            |       | 34         |       | 9            |       | 30 |   | 6 |   | 27 |   |
| Pennsylvania           |       | 18           |       | 18         |       | 17           |       | 17 |   | 14 |   | 14 |   |
| Puerto Rico            |       | 0            |       | 1          |       | 0            |       | 1 |   | 0 |   | 1 |   |
| South Carolina         |       | 11           |       | 11         |       | 10           |       | 10 |   | 8 |   | 8 |   |
| South Dakota           |       | 1            |       | 1          |       | 1            |       | 1 |   | 1 |   | 1 |   |
| Tennessee              |       | 1            |       | 2          |       | 0            |       | 1 |   | 0 |   | 1 |   |
| Texas                  |       | 6            |       | 7          |       | 4            |       | 6 |   | 3 |   | 7 |   |
| Virginia               |       | 20           |       | 23         |       | 20           |       | 23 |   | 18 |   | 20 |   |
| Washington             |       | 3            |       | 29         |       | 3            |       | 22 |   | 3 |   | 22 |   |
| West Virginia          |       | 7            |       | 7          |       | 7            |       | 7 |   | 7 |   | 7 |   |
| Wyoming                |       | 1            |       | 1          |       | 1            |       | 1 |   | 1 |   | 1 |   |
| Total Domestic         |       | 399          |       | 481        |       | 359          |       | 431 |   | 304 |   | 381 |   |
| International - Mexico |       | 37           |       | 37         |       | 37           |       | 37 |   | 35 |   | 35 |   |
| **Total**              |       | 436          |       | 518        |       | 396          |       | 468 |   | 339 |   | 416 |   |

 

At January 1, 2005, ourwholly owned HMO subsidiary leased space within 95 California Wal-Mart stores,including the 70 stores within which we operated a vision center.  Leases for HMO offices that are adjacent toour vision centers expire on the same date the lease for the vision centerexpires, unless extended by agreement with Wal-Mart.  Leases for HMO offices located adjacent tovision centers operated by Wal-Mart expire at various dates.

 

At January 1, 2005, weoperate two leased home medical equipment stores, one in Tennessee and theother in Pennsylvania.

 

10

----

 

The leases for these twolocations are for a five-year term commencing in May 2004.  Because the stores were opened as a test, theleases also provided for an early termination, at our option, after twelvemonths and prior to the end of the eighteenth month.  On February 28, 2005, we notified Wal-Mart ofour intent to terminate the leases during the early termination period.  See “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations - Lease Agreements.”

 

Our corporate offices,retail support center and one of our labs and distribution centers are alllocated in a 66,000 square foot leased facility located in Lawrenceville,Georgia.  This building is leased throughJanuary 2009.

 

A second opticallaboratory and distribution center is located in a 20,000 square foot leasedfacility located in St. Cloud, Minnesota.  This lease expires in October 2007.

 

#### **Item 3.  Legal Proceedings**

#### ** **

***Litigation in Oklahoma. ***On October 5, 2004, we filed a lawsuit in theDistrict Court of Oklahoma County, Oklahoma (Case No. CJ-2004-8170) against theDistrict Attorney for Oklahoma County. Our lawsuit seeks a declaratory judgment that we may operate visioncenters in Oklahoma in space subleased from Wal-Mart.  To date, certain Oklahoma statutes have beenbroadly interpreted as preventing any optical chain from operating visioncenters in space leased from retailers such as Wal-Mart.  We have developed a business model for ourproposed operations in that state that we believe complies with the applicablelegal requirements. On February 19, 2005, a state court judge held that ourproposed business model does not comply with applicable legalrequirements.  We intend to appeal thisdecision.  There are no assurances thatwe will obtain a favorable and final judgement from the Oklahoma courts.

 

***Litigation in California.* **On September 3, 2003, the Second AppellateDistrict of the California Court of Appeal affirmed a prior judgment of the LosAngeles County Superior Court (Case No. BC 274257) dismissing litigation thathad been instituted against us on May 20, 2002 by Consumer Cause, Inc. allegingthat our business model in California failed to comply with applicable legalrequirements.  The complaint soughtattorney fees and an injunction prohibiting us from continuing the allegedviolations.  The case brought by ConsumerCause, Inc. against us was similar to a case previously brought by theCalifornia Attorney General against one of our competitors, alleging, amongother things, that their business model fails to comply with applicable legalrequirements. See “Risk Factors - We are subject to state and local regulationof the vision care industry”.

 

***Other Litigation. ***Weare from time to time involved in litigation in the ordinary course of ourbusiness, none of which has had or is expected to have a material adverseimpact on our financial position or results of operations.

 

#### **Item4.  Submission of Matters to a Vote ofSecurity Holders**

#### ** **

No matters were submittedto a vote of security holders during the last quarter of fiscal 2004.

 

11

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###### **PART II**

###### ** **

**Item5.  Market for Registrant’s Common Stockand Related Stockholder Matters**

 

Our Common Stock islisted on the American Stock Exchange under the symbol “NVI”.  The following table sets forth for theperiods indicated the high and low prices of our Common Stock.

 
| ** **  | ** ** | **Fiscal Quarter Ended** | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------|------------|--------------------------|------------|----------|------------|---------|------------|
| Fiscal 2003 |       | March 29, 2003           |       | $        | 0.47       |    | $          | 0.32 |   |
|        |       | June 28, 2003            |       | $        | 0.69       |    | $          | 0.25 |   |
|        |       | September 27, 2003       |       | $        | 0.90       |    | $          | 0.55 |   |
|        |       | January 3, 2004          |       | $        | 2.75       |    | $          | 0.67 |   |
|        |       |                     |       |     |       |    |       |
| Fiscal 2004 |       | April 3, 2004            |       | $        | 2.56       |    | $          | 1.51 |   |
|        |       | July 3, 2004             |       | $        | 2.62       |    | $          | 1.54 |   |
|        |       | October 2, 2004          |       | $        | 6.20       |    | $          | 2.06 |   |
|        |       | January 1, 2005          |       | $        | 9.25       |    | $          | 4.76 |   |

 

As of February 28, 2005,there were approximately 677holders of record of our Common Stock.

 

We have never paiddividends on our common stock.  Inaddition, both our indenture and our credit facility prohibit us from payingcash dividends.

 

12

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## **Item 6. Selected Financial Data**

## ** **

We emerged frombankruptcy on May 31, 2001.  Effective asof June 2, 2001, we implemented “fresh start” accounting.  As a result, all assets and liabilities wererestated to reflect their respective fair values at that date.  The consolidated financial statements afterthat date are identified as “Successor” financial statements in the table belowand represent those of a new reporting entity. The Successor financial statements are not comparable to the financialstatements of the pre-confirmation company, which are identified as “Predecessor”financial statements in the table below.

 

At the beginning of 2002,we adopted Financial Accounting Standard No. 144, “*Accounting for the Impairment or Disposal of Long-Lived Assets*”(“FAS No. 144”) which includes a requirement that discontinued operations beevaluated at the lowest level to which cash flow is attributed.  Accordingly, except for two of our closedWal-Mart vision centers that we relocated as freestanding stores in 2004, weclassify closed stores as “Discontinued Operations.”  Revenues and expenses attributable to closedHMO offices are also classified as Discontinued Operations, whereas we reportwithin results of continuing operations the operating results of HMO officesthat remain open in a Wal-Mart location after our vision center closes.  Locations that were closed or disposed ofprior to the adoption of FAS No. 144 did not qualify for DiscontinuedOperations presentation and are included in Continuing Operations for theperiods during which they operated.

 

This summary should beread in conjunction with the consolidated financial statements and relatednotes included in this Annual Report on Form 10-K as well as the sections ofthis report entitled Business (Item 1) and Management’s Discussion and Analysisof Financial Condition and Results of Operations (Item 7).

 

13

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| ** **                                                                    | ** ** | ** **    | ** **  | ** **      | ** ** | ** ** | ** ** | **2001**                                    | ** ** | ** **                            | ** ** |
|-------------------------------------------------------------------------------|------------|---------------|-------------|-----------------|------------|------------|------------|---------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                    | ** ** | **2004**      | ** **  | **2003**        | ** ** | **2002**   | ** ** | **Seven months  ended  December 29,  2001** | ** ** | **Five months  ended  June 2,  2001** | ** ** | **2000** | ** ** |
| ** **                                                                    | ** ** | **Successor** | ** **  | **Predecessor** | ** ** |
| **Continuing Operations:**                                                    |       |          |        |            |       |       |       |                                        |       |                                  |       |   |   |
| Total net revenue                                                             |       | $             | 228,852     |            | $          | 216,714    |       | $                                           | 197,822    |                                  | $          | 108,134 |   | $ | 99,346 |   | $ | 257,852 |   |
| Gross profit                                                                  |       | $             | 127,685     |            | $          | 119,182    |       | $                                           | 110,284    |                                  | $          | 60,232 |   | $ | 52,183 |   | $ | 138,004 |   |
| Gross profit percentage                                                       |       | 55.9          | %           | 55.0            | %          | 55.6       | %          | 55.7                                        | %          | 52.5                                  | %          | 53.5 | % |
| Operating income (loss) from continuing operations                            |       | $             | 16,566      |            | $          | 5,378      |       | $                                           | 1,295      |                                  | $          | (8 | ) | $ | (7,409 | ) | $ | (13,301 | ) |
|                                                                          |       |          |        |            |       |       |       |                                        |       |                                  |       |   |   |
| **Discontinued Operations:**                                                  |       |          |        |            |       |       |       |                                        |       |                                  |       |   |   |
| Income from discontinued operations, net of taxes                             |       | $             |  2,252 |            | $          | 1,996      |       | $                                           | 4,564      |                                  | $          | 2,537 |   | $ | 2,185 |   | $ | 6,888 |   |
|                                                                          |       |          |        |            |       |       |       |                                        |       |                                  |       |   |   |
| **All Operations:**                                                           |       |          |        |            |       |       |       |                                        |       |                                  |       |   |   |
| Interest expense                                                              |       | $             | 10,595      |            | $          | 12,913     |       | $                                           | 14,099     |                                  | $          | 8,459 |   | $ | 1,154 |   | $ | 7,783 |   |
| Cumulative effect of change in accounting principle                           |       | —        |        | $               | (564       | )          | —     |                                        | —     |                                  | —     |   | — |   |
| Net earnings (loss)                                                           |       | $             | 12,375      |            | $          | (3,868     | )          | $                                           | (6,204     | )                                     | $          | (5,860 | ) | $ | 113,323 |   | $ | (139,880 | ) |
| ** **                                                                    | ** ** | ** **    | ** **  | ** **      | ** ** | ** ** | ** ** | ** **                                  | ** ** | **(See Note)**                        | ** ** | **(See Note)** | ** ** |
| ** **                                                                    | ** ** | ** **    | ** **  | ** **      | ** ** | ** ** | ** ** | ** **                                  | ** ** | ** **                            | ** ** | ** ** | ** ** |
| **Net earnings (loss) per basic share:**                                      |       |          |        |            |       |       |       |                                        |       |                                  |       |   |   |   |   |   |   |   |   |
| Earnings (loss) from continuing operations                                    |       | $             | 1.99        |            | $          | (1.05      | )          | $                                           | (2.15      | )                                     | $          | (1.68 | ) | $ | 4.44 |   | $ | (6.73 | ) |
| Net earnings (loss)                                                           |       | $             | 2.43        |            | $          | (0.77      | )          | $                                           | (1.24      | )                                     | $          | (1.17 | ) | $ | 5.35 |   | $ | (6.61 | ) |
|                                                                          |       |          |        |            |       |       |       |                                        |       |                                  |       |   |   |
| **Net earnings (loss) per diluted share:**                                    |       |          |        |            |       |       |       |                                        |       |                                  |       |   |   |   |   |   |   |   |   |
| Earnings (loss) from continuing operations                                    |       | $             | 1.81        |            | $          | (1.05      | )          | $                                           | (2.15      | )                                     | $          | (1.68 | ) | $ | 4.44 |   | $ | (6.73 | ) |
| Net earnings (loss)                                                           |       | $             | 2.21        |            | $          | (0.77      | )          | $                                           | (1.24      | )                                     | $          | (1.17 | ) | $ | 5.35 |   | $ | (6.61 | ) |
|                                                                          |       |          |        |            |       |       |       |                                        |       |                                  |       |   |   |
| **Balance Sheet Data:**                                                       |       |          |        |            |       |       |       |                                        |       |                                  |       |   |   |
| Total assets                                                                  |       | $             | 135,110     |            | $          | 140,297    |       | $                                           | 153,801    |                                  | $          | 171,217 |   | $ | 186,688 |   | $ | 90,888 |   |
| Long-term debt                                                                |       | $             | 72,930      |            | $          | 94,939     |       | $                                           | 105,882    |                                  | $          | 118,403 |   | $ | 120,000 |   | $ | 139,109 |   |
| Shareholders’ equity (deficit)                                           |       | $             | 21,422      |            | $          | 8,870      |       | $                                           | 12,829     |                                  | $          | 19,274 |   | $ | 25,000 |   | $ | (113,323 | ) |
|                                                                          |       |          |        |            |       |       |       |                                        |       |                                  |       |   |   |
| **Cash Flow Data:**                                                           |       |          |        |            |       |       |       |                                        |       |                                  |       |   |   |
| Net cash provided by operating activities                                     |       | $             | 23,725      |            | $          | 10,802     |       | $                                           | 13,124     |                                  | $          | 4,813 |   | $ | 9,564 |   | $ | 18,589 |   |
| Depreciation and amortization                                                 |       | $             | 13,542      |            | $          | 15,962     |       | $                                           | 18,999     |                                  | $          | 11,425 |   | $ | 4,808 |   | $ | 17,526 |   |
| Capital expenditures                                                          |       | $             | 5,137       |            | $          | 4,517      |       | $                                           | 5,209      |                                  | $          | 2,750 |   | $ | 2,084 |   | $ | 5,379 |   |
|                                                                          |       |          |        |            |       |       |       |                                        |       |                                  |       |   |   |
| **Statistical Data:**                                                         |       |          |        |            |       |       |       |                                        |       |                                  |       |   |   |
|                                                                          |       |          |        |            |       |       |       |                                        |       |                                  |       |   |   |
| Vision centers open at end of period: Leased  department vision centers       |       | 414           |        | 468             |       | 518        |       | 514                                         |       | 503                                   |       | 499 |   |
| Freestanding vision centers                                                   |       | 2             |        | —          |       | —     |       | —                                      |       | —                                |       | 226 |   |
| Number of closed retail optical locations: Included  in continuing operations |       | —        |        | —          |       | —     |       | —                                      |       | 226                                   |       | 322 |   |
| Included in discontinued operations                                           |       | 58            |        | 112             |       | 113        |       | 113                                         |       | 109                                   |       | 91 |   |
|                                                                               |            |               |             |                 |            |            |            |                                             |            |                                       |            |  |  |  |  |  |  |  |  |  |  |

 

----

**Note:****                  **The net loss for 2000 includes reorganizationexpenses of $121.5 million, of which $100.8 million represented impairment ofgoodwill.  Net earnings for the fivemonths ended June 2, 2001, include net reorganization gains of $96.5 million, withmore than 100% of such net gains arising from our implementation of  fresh-start accounting.

 

14

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**Item 7.  Management’s Discussion and Analysis ofFinancial Condition and Results** o**f Operations**

 

## **Overview**

## ** **

We are primarily anoptical retailer.  More than 96% of our2004 net revenue from continuing operations was derived from sales ofprescription eyewear (spectacles and contact lenses) and other opticalmerchandise we sell in the 414 vision centers we operated as of January 1, 2005within host environments and from our two recently opened freestanding stores.

 

Wal-Mart is our mostimportant vision center host. Our locations inside domestic Wal-Mart storesaccount for 73% of our total store count at January 1, 2005, and 82% of our netrevenue from continuing operations for the year then ended.  We have closed 96 of our domestic Wal-Martlocations in the last three fiscal years, primarily because our contractualright to continue to occupy the space expired, and we expect another 33 leasesto expire in 2005.  Although we believethat we maintain an excellent tenant relationship with Wal-Mart, we nonethelessbelieve that Wal-Mart will continue its practice of opening its own domesticcorporate vision centers in the spaces we vacate.  Accordingly, we do not believe that Wal-Martwill offer to extend any of our expiring leases in the United States.

 

We seek to be a growthretailer.  The domestic Wal-Mart storeclosings represent a significant challenge to overcome if we are to achieve ourobjective.  Our primary strategies as weentered 2004 were to:

 

•                  optimizethe profitability of our existing store base to maximize the time we have todevelop sustainable growth vehicles,

 

•                  developgrowth opportunities within optics but outside of Wal-Mart, and

 

•                  drawingupon our strong relationship with Wal-Mart, test non-optics retail opportunitiesinside Wal-Mart stores.

 

The following discussionprovides information regarding our progress against these three primarystrategies, our primary objectives for 2005, changes in certain key operatingmeasures over the last three years, how certain accounting principles affectour financial statements, our arrangements for leased retail space and ourliquidity.  This discussion should beread in conjunction with our financial statements and notes included herein.

 

## **Summary of 2004Results**

## ** **

During 2004, we madegreat progress towards optimizing the profitability of our existing store base,we tested a non-optics retail opportunity inside Wal-Mart and we continued toattempt to develop other growth opportunities within optics.  The year’s highlights were:

 

•                  Ourdomestic comparable store sales growth, a key internal measure of operatingsuccess used by retailers, was +6.5%. This was on top of domestic comparable store sales growth of +6.1% inthe prior year.

 

•                  Grossmargins achieved on our continuing operations sales of optical products andservices grew 110 basis points to 56.6%.

 

•                  Netcash provided by operating activities grew to $23.7 million, a 120% increasefrom net cash provided by operating activities in 2003 and the highest suchmeasure in the Company’s history.

 

•                  Netincome of $12.4 million represented a profit turnaround of $16.2 million versusthe prior year.

 

•                  Werealized gains of $3.2 million on repurchases of our Senior Subordinated Notes.

 

•                  Wereduced the outstanding balance of our Senior Subordinated Notes by 18.5%, from$95.5 million at January 3, 2004, to $77.8 million at January 1, 2005.  Subsequently, we made an additional paymentof principal of $4.9 million in February 2005, reducing the Note balance to$72.9 million.

 

•                  Werelocated two of our Wal-Mart vision centers, in West Berlin, New Jersey, andWatertown, New York, to freestanding locations. These are the first two locations in what we expect to be an expandingtest of our ability to operate outside of host environments.

 

•                  Wecontinued to grow our military business, with a net gain of three stores duringthe year and successful bids for

 

15

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three morelocations that will open during the first half of 2005.  Through March 21, 2005, we have opened two ofthese locations and been awarded a contract for one additional location.

 

•                  Wefiled a lawsuit in Oklahoma that, if successful, could potentially enable us toopen vision centers leased from Wal-Mart in that state.  We can provide no assurance of a favorableoutcome.  If the legal outcome isfavorable, we can provide no assurance that Wal-Mart would lease space to us inOklahoma. See “Legal Proceedings”.

 

•                  Weexpanded our California HMO into new Wal-Mart and Sam’s Club locations in whichWal-Mart operates a vision center.

 

Additionally, in May 2004our Board of Directors engaged TM Capital Corp. as financial advisors to reviewour strategic alternatives and we have engaged in extensive discussions andinvestigation of several of these alternatives.

 

The foundation for theoperational improvements we achieved in 2004 had, in fact, been put into placein the last half of 2002 and throughout, but particularly in the first half of2003.  Changes made during that periodaffected almost every aspect of our base business, including:

 

•                  ourframe and lens selection and the number of suppliers from which we purchasedthese components,

 

•                  thematerials used to help consumers better understand the spectacle lens choicesavailable to them,

 

•                  pricingand organization of in-store spectacle frame displays,

 

•                  storestaffing levels,

 

•                  incentiveprograms for store managers and other store associates, and

 

•                  storemanager and associate training and evaluation measurements.

 

In addition to thesechanges in store operations, during August 2003 we reduced home office andfield supervision staffing levels.

 

During 2004 we made fewerchanges, but continued to enhance our training programs and refine our productprocurement activities with initiatives that included the direct importation ofa limited number of spectacle frames.

 

**PrimaryObjectives for 2005**

 

The TM Capital review ofour strategic alternatives is continuing. Such strategic alternatives could possibly include a refinancing of the12% Notes or a more extensive recapitalization, a sale of the Company or acontrolling interest therein, or a merger with or acquisition of another entityor other entities.  We have engaged inextensive discussions and investigation of several of these alternatives.  Because there is no assurance that any suchtransaction will be pursued or, if pursued, consummated, the discussion thatfollows does not take into consideration the potential effects of alternativesthat could arise as a result of this strategic review.

 

Our primary objectiveremains as it has been - to develop ways to overcome the projected annualreduction of our vision centers inside Wal-Mart and become a growthretailer.  To this end, in 2005 ourobjectives are to:

 

•                  maintain or improve upon the per-storeprofitability levels we achieved in our base business in 2004,

 

•                  expand by 12 to 18 stores our test ofrelocating vision centers to freestanding store locations as their leases inWal-Mart expire,

 

•                  develop other avenues for growth inoptical retailing, and

 

•                  continue to grow the number ofoptometric offices operated in California by our HMO subsidiary.

 

We believe that we willcontinue to achieve strong operating results in 2005, but that our net incomewill decline from its 2004 level for the following reasons:

 

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•                  we expect to lose another 33 of ourvision center leases inside domestic Wal-Mart stores and our Wal-Mart visioncenters are, on average, our most profitable locations,

 

•                  we expect that the planned 12 to 18relocated freestanding locations will not achieve profitable operating levelsduring 2005 due to the timing of their openings throughout the year, heavyinitial promotional spending and as their sales levels ramp up,

 

•                  we are likely to incur costs andpossibly initial operating losses associated with other new optical retailopportunities,

 

•                  we do not expect to be able toduplicate the $3.2 million in pre-tax gains included in 2004 results fromrepurchases of our Notes at discounted prices, and

 

•                  2004 net income benefited from thereversal of our deferred income tax valuation allowance.  While the amount of income taxes we payshould remain relatively low in 2005, at approximately 5% of consolidatedpre-tax income, we expect to record an income tax provision of between 36% and40% of pre-tax income (see “Critical Accounting Policies and Estimates -Accounting for Income Taxes” below).

 

## **Results ofOperations**

## ** **

***Total Net Revenue.* **Total net revenue from continuingoperations consists of sales of optical products and services fees from managedvision care services and sales of home medical products and services.  We operate on a 52/53 week fiscal year.  Fiscal 2003 contained 53 weeks whereas fiscal2004 and fiscal 2002 each contained 52 weeks.

 

Sales of optical productsand services increased 4.9% in 2004 compared to 2003 and 7.3% in 2003 comparedto 2002, whereas comparable store sales increased 6.5% in 2004 and 5.7% in2003.  Comparable store sales arecomputed based upon stores that were open in the same month of each year withinthe comparison periods and exclude 2003’s extra week.  During 2003 we made several operationalchanges designed to improve our sales performance.  These changes positively impacted 2003 salesand had a continuing positive impact on 2004 sales.  While it is difficult to quantify the effectof each of these changes, we believe the following initiatives had the mostsignificant impact on retail sales in 2004 and 2003.

 

1.               In May 2003, webegan offering a twelve-month extended warranty plan to provide for repair andreplacement of eyeglasses during the first year after purchase.  Revenue recognized from the sales of thewarranty plan was approximately $5.4 million in 2004 compared to $1.2 millionin 2003.  Amounts collected from the saleof these warranties are recognized as revenues over the twelve-month warrantyperiod on a straight-line basis.  Thus,the year-over-year increase in warranty plan revenue is the result of both (a)selling the plan for all twelve months in 2004 and (b) reaching the point, inMay 2004, where monthly revenues recognized approximated one month’s sales ofthe plan.  Incremental revenues fromsales of this warranty plan are, therefore, expected to slow in 2005,particularly beginning in May.

 

2.               We implementedsignificant merchandising changes in every major product category (frames,spectacle lenses, contact lenses and accessories).  The most significant category changes were asfollows:

 

a.         In the first quarter of2003, we updated our frame collection to modernize and simplify ourpresentation.  As part of this process,we substantially reduced the number of frame vendors, consolidated price pointsand enhanced the presentation of frames to make them more brand focused for thecustomer and easier to manage for our associates.

 

b.        In the fourth quarter of2003, we consolidated our lens offering to simplify the sales process for ourassociates and make it easier for the customer to select the lenses that bestfit their needs.

 

c.               During the first halfof 2003, we aligned our contact lens selection with the products mostfrequently prescribed by our independent doctors.  This favorably impacted our contact lenssales, which were up approximately 8% in 2004 over 2003 and increasedapproximately 9% in 2003 compared to 2002.

 

d.              We also updated ouraccessory collection to complement our spectacle offering, increasing 2003accessory sales by approximately 19% over 2002.

 

3.               We restructured ourpersonnel scheduling at the store-level to provide for consistent coveragebased on operating

 

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needsby sales volume levels.

 

4.               We amended ourincentive programs to increase potential participation by, and therefore theproductivity of, our associates.

 

5.               In January 2003, webegan manufacturing eyeglasses for a small retail optical company.  Total revenue from this line of business wasapproximately $966,000 and $877,000 in 2004 and 2003, respectively.

 

Managed care salesaccounted for approximately 11%, 12% and 11% of our sales of optical productsin 2004, 2003 and 2002, respectively.  Wework with large and small managed care payors to provide vision benefits totheir members.  We expect that salesthrough managed vision care programs will continue to represent a significantpercentage of total retail industry optical sales.  (See “Risk Factors - Our declining base ofvision centers in Wal-Mart stores could make it more difficult for us tocompete.”)  Changes in the managed visioncare industry can significantly impact our sales.  Effective October 1, 2003, a large nationalmanaged care payor changed its policy regarding out-of-network providers.  These changes limited our ability to verifybenefit coverage and to accept assignment of the payor’s benefits on behalf ofcertain of our customers.  In 2003, wegenerated sales of approximately $3.2 million as an out-of-network provider forthis payor.  In 2004, sales from thissource declined to $186,000.  We areworking aggressively to mitigate the decreases in lost sales.  We will continue to work toward adding thirdparty plans and payors as part of our ongoing managed care growth strategy.

 

During the second quarterof 2002, a wholly owned subsidiary (the “HMO”) began aggressively marketing eyeexamination products and services as a specialized health care service plan inCalifornia.  Until January 2004, the HMOoperated optometric examination offices only in California Wal-Mart stores inwhich we operated the vision center.  InJanuary 2004, we also began operating optometric examination offices in certainCalifornia Wal-Mart stores in which Wal-Mart operates the vision center.  Fees from managed care vision servicesinclude premiums from the HMO’s managed care insurance product and, commencingin 2004,  patient co-payments for examfees.

 

The increases in feesfrom managed care vision services in 2004 and 2003 are largely attributable toincreased enrollments in our HMO.  TheHMO had approximately 168,000, 150,000 and 48,000 members at the end of 2004,2003 and 2002, respectively.  In 2004 we alsogenerated revenue from patient co-payments of approximately $472,000.

 

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***Gross Profit.* **The components of sales and gross profitfrom continuing operations are detailed below (dollars in thousands):

 
|                           |   | **2004** |    | **2003** |   | **2002** |   |
|--------------------------------|--------|----------|---------|----------|--------|----------|--------|
| Optical Products and Services: |   |     |    |     |   |     |   |   |   |   |   |   |   |
| Sales, net                     |   | $        | 220,759 |     | 100.0  | %        | $      | 210,368 |   | 100.0 | % | $ | 196,123 |   | 100.0 | % |
| Cost of goods sold             |   | 95,909   |    | 43.4     | %      | 93,685   |   | 44.5 | % | 86,139 |   | 43.9 | % |
|                           |   |     |    |     |   |     |   |   |   |   |   |   |   |
| Gross profit                   |   | $        | 124,850 |     | 56.6   | %        | $      | 116,683 |   | 55.5 | % | $ | 109,984 |   | 56.1 | % |
|                           |   |     |    |     |   |     |   |   |   |   |   |   |   |
| Managed Care Vision Services:  |   |     |    |     |   |     |   |   |   |   |   |   |   |
| Revenue                        |   | $        | 7,835   |     | 100.0  | %        | $      | 6,346 |   | 100.0 | % | $ | 1,699 |   | 100.0 | % |
| Claims expense                 |   | 5,066    |    | 64.7     | %      | 3,847    |   | 60.6 | % | 1,399 |   | 82.3 | % |
|                           |   |     |    |     |   |     |   |   |   |   |   |   |   |
| Gross profit                   |   | $        | 2,769   |     | 35.3   | %        | $      | 2,499 |   | 39.4 | % | $ | 300 |   | 17.7 | % |
|                           |   |     |    |     |   |     |   |   |   |   |   |   |   |
| Home Medical Products:         |   |     |    |     |   |     |   |   |   |   |   |   |   |
| Sales                          |   | $        | 258     |     | 100.0  | %        |   |   |   |   |   |   |   |   |
| Cost of sales                  |   | 192      |    | 74.4     | %      |     |   |   |   |   |   |   |   |
| Gross profit                   |   | $        | 66      |     | 25.6   | %        |   |   |   |   |   |   |   |   |
|                           |   |     |    |     |   |     |   |   |   |   |   |   |   |
| Total net revenue              |   | $        | 228,852 |     | 100.0  | %        | $      | 216,714 |   | 100.0 | % | $ | 197,822 |   | 100.0 | % |
| Total cost of goods sold       |   | 101,167  |    | 44.2     | %      | 97,532   |   | 45.0 | % | 87,538 |   | 44.3 | % |
|                           |   |     |    |     |   |     |   |   |   |   |   |   |   |
| Total gross profit             |   | $        | 127,685 |     | 55.8   | %        | $      | 119,182 |   | 55.0 | % | $ | 110,284 |   | 55.7 | % |
|                                |        |          |         |          |        |          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The improvement ingross margin on sales of optical products and services to 56.6 % in 2004compared to 55.5 % in 2003 was attributable to several factors:

 

1.               Eyeglass marginsimproved 50 basis points in 2004 compared to 2003.  The improvement in margins was attributablein part to an increase in revenue recognized from the sale of our twelve-monthextended warranty plan to approximately $5.4 million in 2004 compared to $1.2million in 2003.  Eyeglass margins in2004 were also favorably impacted by a change in our single vision lensoffering made in the fourth quarter of 2003, changes made to our multifocallens offering in 2004 and a reduction in remake and warranty claims in 2004.  These factors were partially offset by lowermargins on an increased level of promotional sales, such as the free framespromotion for the purchase of a second pair of eyeglasses which resulted inincreased sales and a reduction in inactive inventory, but at reduced margins.

 

2.               A revision in thelease agreement covering all of our Fred Meyer locations became effective inJanuary 2004 resulting in a decrease in rent (a component of cost of sales) forthese stores.  We experienced savings inrent expense of approximately $1.2 million in 2004 compared to 2003 whichfavorably impacted margins as a percent of sales by approximately 0.5%.

 

3.               Margin on contactlens sales improved in 2004 compared to 2003 due to a change to new extendedwear contact lens products with higher gross margins.

 

Partially offsettingthese improvements in the retail gross margin percentage was a shift in productmix to a higher percentage of contact lens sales and a lower percentage ofeyeglass sales.  Contact lens sales, whichyield a lower margin than do eyeglass sales, increased by $3.4 million to $45.8million or 20.8% of total sales of optical products and services in 2004 from$42.4 million or 20.1% of total sales of optical products and services in2003.  Our eyeglass sales, which includerevenue recognized from the sale of our twelve-month extended warranty plan,increased $7.3 million to $165.6 million in 2004 from $158.3 million in 2003,but as a percent of total sales of optical products and services they declinedto 75.0% in 2004 from 75.2% in 2003.  A continuationof this trend of declining eyeglass sales as a percent of total sales wouldhave a negative impact on our gross margins.

 

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The gross margin on salesof optical products and services declined to 55.5 % in 2003 compared to 56.1 %in 2002 due primarily to a shift in product mix to a higher percentage ofcontact lens sales and a lower percentage of eyeglass sales.  Contact lens sales increased by $3.5 million to$42.4 million or 20.1% of total sales of optical products and services in 2003from $38.9 million or 19.8% of total sales of optical products and services in2002.  Eyeglass sales increased $7.9million over 2002 but as a percent of total sales of optical products andservices, they declined to 75.2% in 2003 compared to 76.7% in 2002.

 

Partially offsetting theeffect of the shift in product mix was revenue of $1.2 million recognized in2003 from the sale of our twelve-month extended warranty plan.  We also saw a slight improvement in eyeglass marginsas a result of the change in lens offering made in the fourth quarter of 2003.

 

The gross profit onmanaged care vision services represents premium revenue and patient co-paymentsless claims expenses and the cost of operating our optometric examinationoffices.

 

***Selling, General and Administrative Expense (“SG&Aexpense”). ***SG&Aexpense consists of the following (dollars in thousands):

 
| ** **                               | ** ** | **2004**   | ** ** | **2003**                | ** ** | **2002**   | ** ** |
|------------------------------------------|------------|------------|------------|-------------------------|------------|------------|------------|
| ** **                               | ** ** | **Amount** | ** ** | **% of Total  Revenue** | ** ** | **Amount** | ** ** | **% of Total  Revenue** | ** ** | **Amount** | ** ** | **% of Total  Revenue** | ** ** |
| Store operating expense                  |       | $          | 71,165     |                    | 31.1       | %          | $          | 72,689 |   | 33.5 | % | $ | 67,549 |   | 34.1 | % |
| Store depreciation and amortization      |       | 3,373      |       | 1.5                     | %          | 5,503      |       | 2.5 | % | 8,590 |   | 4.4 | % |
| Field supervision                        |       | 5,321      |       | 2.3                     | %          | 6,176      |       | 2.9 | % | 6,297 |   | 3.2 | % |
| Corporate support                        |       | 22,364     |       | 9.8                     | %          | 20,391     |       | 9.4 | % | 18,149 |   | 9.2 | % |
| Amortization of Wal-Mart contract rights |       | 7,509      |       | 3.3                     | %          | 7,523      |       | 3.5 | % | 7,563 |   | 3.8 | % |
| Other depreciation and amortization      |       | 1,051      |       | 0.5                     | %          | 776        |       | 0.4 | % | 841 |   | 0.4 | % |
| Impairment of long-lived assets          |       | 336        |       | 0.1                     | %          | 262        |       | 0.1 | % |   |   |   |   |
| Restructuring expense                    |       |       |       |                    |       | 484        |       | 0.2 | % |   |   |   |   |
| Total SG&A expense                   |       | $          | 111,119    |                    | 48.6       | %          | $          | 113,804 |   | 52.5 | % | $ | 108,989 |   | 55.1 | % |

 

Store operating expenses,which do not include rent and other occupancy costs, declined in 2004 comparedto 2003 primarily as a result of reductions in payroll and benefit costs,telephone and supplies expense, and managed care claims processing costs.  Payroll savings were attributable to our newpersonnel scheduling and incentive plans implemented to control employeecosts.  Reductions in benefit costs werethe result of lower health insurance and workers compensation insuranceclaims.  Negotiation of new contracts fortelephone service and implementation of a new managed care claims systemgenerated savings in these areas.  Supplycosts were lower in 2004 because the prior year included large expensesnecessitated by the many operational changes made in the stores during 2003 toimprove sales and margins.

 

Store operating expensesin 2003 increased 7.6% compared to 2002 but declined as a percentage of totalrevenue.  The increase in expenses in2003 was due primarily to higher payroll and benefits costs, increasedadvertising costs and higher workers compensation insurance claims.  The increase in payroll costs wasattributable in part to higher pay rates in certain markets where availabilityof dispensing opticians and growing competition resulted in upward pressure onrates for optical personnel.  Also, storelevel incentive costs increased in 2003 due to a change in the incentive structurecombined with improved sales performance. Advertising costs increased approximately $567,000 in 2003 over 2002 aswe stepped up promotional activities to improve sales.  Increases in health insurance costs andworkers compensation insurance costs were due in part to the increasing cost ofmedical services and an adverse development of claims from previous years,particularly in California.

 

Store depreciation costsdeclined in both 2004 and 2003 compared to the respective prior year due toleasehold improvements and equipment at some stores becoming fully depreciated.

 

Field supervision expensedeclined in both 2003 and 2004 compared to the prior year due to a reduction inthe number of regional and district managers.

 

Corporate supportexpenses increased in both 2004 over 2003 and 2003 over 2002.  The increase in 2003 over 2002 was primarilyattributable to higher health insurance costs, increased incentive compensationand an increase in professional fees,

 

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a portion of which wasrelated to the re-audit of our 2001 financial statements.

 

The increase in corporatesupport expenses in 2004 over 2003 was primarily attributable to accruals madefor incentive compensation expense. In 2004 we recorded expense ofapproximately $5.2 million for incentives earned under various incentive plans,representing an increase of $4.2 million over similar expenses recorded in2003.   The two largest components of the2004 expenses were (1) approximately $3.0 million accrued under the 2004short-term incentive plan and (2) approximately $1.5 million accrued under along-term incentive plan implemented in 2002. Incentives payable under theshort-term plan were based upon the substantial year-over-year increase in ouroperating results. Incentives payable under the long-term plan were based uponcumulative adjusted EDITDA (as defined) achieved during the three fiscal yearsended January 1, 2005. A portion of the expense recorded under the long termplan in 2004 reflects an increase in the market value of our common stockduring the year because the final payments due thereunder were determined byour 2004 year end closing stock price. Declines in professional fees and retail support center payroll costspartially offset the increase in incentive plan accruals. The reduction inprofessional fees was the result of operational consulting fees and unusuallyhigh audit and tax return preparation fees incurred in 2003. The decrease inpayroll costs was attributable to corporate office staff reductions made in thesecond half of 2003.

 

The increase in otherdepreciation and amortization in 2004 compared to 2003 was due primarily to thepurchase of a new software system for processing managed care claims.

 

We assess the impairmentof all identifiable intangible and long-lived assets on an annual basis andwhenever events or changes in circumstances indicate that the carrying valuemay not be recoverable.  In 2004 weidentified 14 vision centers in Wal-Mart, Wal-Mart de Mexico and Fred Meyerwith a history of operating losses that we do not expect to becomeprofitable.  In addition, we determinedthat our two home medical equipment stores would be closed or disposed ofduring 2005.  As a result, we haverecorded a non-cash impairment charge of $336,000 in 2004 to write down thelong-lived assets for these locations to their fair market value.  The impairment charge for 2003 representsimpairment charges recorded in 2003 for those stores that are included incontinuing operations at the end of 2004. The 2003 impairment charges for 19 stores that were closed during 2004are included as a component of income from discontinued operations.

 

During August 2003, weinitiated and completed a restructuring of the retail field and home officeretail support center.  The processresulted in a reduction in headcount approximating 15% of both the retail fieldmanagement organization and the home office retail support center organization.  The cost of the restructuring process was$484,000, which included separation costs and outplacement costs.  The annual payroll and related costsrepresented by the reduction in force was approximately $1.9 million.

 

***Interest Expense.*** The outstanding balance of our long-termSenior Subordinated Notes is the primary driver of interest expense.  Interest expense decreased approximately $2.3million in 2004 compared to 2003 and $1.2 million in 2003 compared to2002.  These decreases were due primarilyto the mandatory redemptions and Note repurchases made during each year.  The following table shows the annual activityin these Notes (in thousands):

 
| ** **                                                  | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                        |       |     |       |     |       |     |       |
| Senior subordinated notes outstanding at beginning  of year |       | $        | 95,484     |     | $          | 109,706  |       | $ | 120,000 |   |
| Mandatory redemptions at par                                |       | (2,551   | )          | (8,161   | )          | (5,796   | )          |
| Repurchases at discounted prices                            |       | (15,145  | )          | (6,023   | )          | (4,498   | )          |
| Retirement of unissued Notes                                |       | —   |       | (38      | )          | —   |       |
| Senior subordinated notes outstanding at end of year        |       | $        | 77,788     |     | $          | 95,484   |       | $ | 109,706 |   |
|                                                        |       |     |       |     |       |     |       |
| Weighted average balance outstanding for the year           |       | $        | 86,451     |     | $          | 104,366  |       | $ | 115,526 |   |

 

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***Gain on Repurchase of Notes. ***During 2004, 2003 and 2002, we repurchased ourSenior Subordinated Notes and recorded gains from those repurchases as shownbelow (in thousands):

 
| ** **                  | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|----------|------------|
|                        |       |     |       |     |       |     |       |
| Face value repurchased      |       | $        | 15,145     |     | $          | 6,023    |       | $ | 4,498 |   |
| Purchase price              |       | 11,979   |       | 3,702    |       | 2,932    |       |
| Gain on repurchase of Notes |       | $        | 3,166      |     | $          | 2,321    |       | $ | 1,566 |   |

 

***Income Tax Expense (Benefit)******.*** Income tax expense in both 2004 and 2003 consists of amounts we expectto pay under federal alternative minimum tax provisions and in states in whichour taxable income cannot be offset by our net operating loss carry-forwardsplus deferred income tax provisions, offset in 2004 by a reduction in thepreviously recorded valuation allowance. At January 1, 2005, as a result of our substantial improvement inprofitability in 2004 and improved outlook for future profits, we eliminatedthe remaining balance of $1,203,000 in the deferred tax valuationallowance.  This adjustment created a netcredit provision for the year. We expect our provision for income taxes toincrease significantly in 2005.  See “CriticalAccounting Policies and Estimates - Accounting for Income Taxes.”

 

***Discontinued Operations. ***During 2004, we closed 55 vision centers insideWal-Mart stores located in the United States, two vision centers in Wal-Mart deMexico stores and three vision centers on military bases. Two of the visioncenters closed inside domestic Wal-Mart locations relocated to freestandinglocations within the vicinity of the closed locations.  During 2003, we closed 40 vision centersinside domestic Wal-Mart locations, twelve vision centers in Fred Meyer stores  and two vision centers on militarybases.  Historical operating results forthese closed vision centers, excluding the vision centers that we relocated tofreestanding locations in 2004, have been classified as discontinued operationsand presented separately for all periods presented in the accompanyingCondensed Consolidated Statements of Operations.  During 2003, we also closed eight HMO officesthat were located next to vision centers we closed concurrently in CaliforniaWal-Mart stores.  The historicaloperating results for these HMO offices have also been classified asDiscontinued Operations.  The historicalresults of HMO offices that remain open in a Wal-Mart location after our visioncenter closes are included in Continuing Operations.  Condensed information for these closed storesfollows (in thousands):

 
| ** **                | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|
|                      |       |     |       |     |       |     |       |
| Total net sales           |       | $        | 13,970     |     | $          | 36,433   |       | $ | 49,198 |   |
| Operating income          |       | $        | 2,344      |     | $          | 2,204    |       | $ | 4,557 |   |
| Income (loss) on disposal |       | $        | (57        | )        | $          | (146     | )          | $ | 7 |   |
| Income taxes              |       | $        | 35         |     | $          | 62       |       |   |   |

 

The 2003 operating incomeincludes a non-cash impairment charge of $288,000 to write down the long-livedassets for certain of the stores closed in 2004 to their fair marketvalue.  The loss on disposal of theseoperations includes severance, closing costs and gains recorded from the saleof certain assets.

 

***Cumulative Effect of a Change in Accounting Principle.* **We adopted Emerging Issues Task ForceIssue No. 02 — 16, “Accounting by a Customer for Certain Consideration Receivedfrom a Vendor” (“EITF 02-16”) at the beginning of 2003. This Issue addressesthe method by which retailers account for vendor allowances. Prior to fiscal2003, we received vendor allowances through co-op advertising agreements, whichwere classified in the income statement as a reduction of advertisingexpense.  As a result of the adoption ofEITF 02-16, certain vendor allowances, which formerly were treated as areduction in advertising costs, began to be presented as a reduction ofinventory cost and subsequently as a component of cost of goods sold.  On the first day of fiscal 2003, we recordedadditional expense of $564,000 as the cumulative effect for this change inaccounting principle.  This amount reflectsthe portion of vendor allowances that would have reduced inventory costs hadthis new accounting pronouncement been in effect at the end of 2002.

 

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**LeaseAgreements**

 

***Vision CenterLease Agreements****. *Ourvision center operations are governed by occupancy agreements, all but two ofwhich are with our hosts.  The tablebelow sets forth key data about each of these agreements: 

 
| ** **                | ** ** | **No. of  Stores  January 1, 2005** | ** ** | **Length of Initial  Base Term (years)** | ** ** | **Length of Option  Terms (years)** | ** ** | **No. of  Options  Exercisable in  Fiscal 2005** | ** ** |
|---------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|-------------------------------------|------------|-------------------------------------------------------|------------|
|                      |       |                                     |       |                                     |       |                                |       |                                                  |       |
| Vision Centers Located In |       |                                     |       |                                     |       |                                |       |                                                  |       |
| Wal-Mart:                 |       |                                     |       |                                     |       |                                |       |                                                  |       |
| Domestic                  |       | 304                                      |       | 9                                        |       | 3                                   |       | 19                                                    |       |
| Mexico                    |       | 35                                       |       | 5                                        |       | 5                                   |       | 6                                                     |       |
| Fred Meyer                |       | 47                                       |       | 3                                        |       | None                                |       | N/A                                                   |       |
| U.S. Military Bases       |       | 28                                       |       | 2 to 7                                   |       | None                                |       | N/A                                                   |       |
| Freestanding stores       |       | 2                                        |       | 5                                        |       | 5                                   |       | None                                                  |       |

 

Under our master licenseagreement with Wal-Mart, we are required to notify Wal-Mart of our intent toexercise the renewal option at least six months prior to the expiration of thebase term.  As of January 1, 2005, we hadnotified Wal-Mart of our intention to exercise the three year option to extendall 15 leases whose base terms expire during the first six-months of 2005.  Because we must notify Wal-Mart of ourintention to renew each lease six months prior to its scheduled expiration, thenumber of options exercisable in fiscal 2005 in the above table is based uponleases in domestic Wal-Mart locations that are scheduled to expire between July1, 2005 and June 30, 2006, excluding leases that we expect to be automaticallyextended as a result of Supercenter conversions (see “Domestic Wal-Mart VisionCenters” below).

 

***Lease Expiration Dates. ***The following table sets forth the number of our vision center leasesthat expire each year, assuming that we exercise all available options toextend the terms of the leases except in one instance where we declined torenew a lease within a domestic Wal-Mart store that will expire in July2005.  As described under “DomesticWal-Mart Vision Centers” below, we expect the leases for nine of our domesticWal-Mart vision centers to be extended as a result of Supercenter conversionsscheduled for 2005.  The table does notpresume any other potential future lease extensions from Supercenterconversions.

** **
| ** **              | ** ** | **Leases Expiring In Fiscal Year** | ** ** |
|-------------------------|------------|------------------------------------|------------|
| ** **              | ** ** | **2005**                           | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **2013** | ** ** | **2014** | ** ** | **2015** | ** ** | **2016** | ** ** | **2017** | ** ** |
| **Host Company:**       |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Wal-Mart                |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Domestic                |       | 33                                 |       | 36 |   | 40 |   | 27 |   | 39 |   | 13 |   | 17 |   | 29 |   | 14 |   | 14 |   | 18 |   | 15 |   | 9 |   |
| Mexico                  |       | 15                                 |       | 5 |   | 8 |   | — |   | — |   | 1 |   | 4 |   | — |   | 2 |   | — |   | — |   | — |   | — |   |
| Fred Meyer              |       | —                             |       | 47 |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Military                |       | 8                                  |       | 7 |   | 2 |   | 4 |   | — |   | — |   | 7 |   | — |   | — |   | — |   | — |   | — |   | — |   |
| **Freestanding stores** |       | —                             |       | — |   | — |   | — |   | 2 |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Totals                  |       | 56                                 |       | 95 |   | 50 |   | 31 |   | 41 |   | 14 |   | 28 |   | 29 |   | 16 |   | 14 |   | 18 |   | 15 |   | 10 |   |

** **

***DomesticWal-Mart Vision Centers.***   Our master licenseagreement with Wal-Mart gave us the right to open 400 vision centers, the lastfive of which were opened in 2001.  Underthis master license agreement, the base term of our lease in each domesticWal-Mart store is nine years.  We have anoption to renew each lease for an additional three years, providing us with atotal lease term of twelve years. Therefore, but for the provision described in the following paragraph,and assuming we exercised the renewal option, we would have expected to closeour last domestic Wal-Mart vision center in October 2013, twelve years afterthe final such vision center had opened.

 

The master licenseagreement also provides that if, at any time during our base or renewal leaseterm in a store, Wal-Mart converts the store to a Supercenter and relocates ourvision center, our lease term in that store will start over.

 

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Through January 1, 2005,our leases in 91 domestic Wal-Mart locations have been extended as a result ofSupercenter conversions, including a total of 47 in the last three years, withthe following results:

 
| **Year of Conversion** | ** ** | **Number of  Conversions** | ** ** | **Average Age of Our  Vision Centers at  Date of Conversion** | ** ** |
|------------------------|------------|----------------------------|------------|---------------------------------------------------------------|------------|
| 2002                   |       | 14                         |       | 9 years, 6 months                                             |       |
| 2003                   |       | 18                         |       | 9 years, 5 months                                             |       |
| 2004                   |       | 15                         |       | 10 years, 5 months                                            |       |

 

Of the 304 stores weoperated inside Wal-Mart at January 1, 2005, we believe that 133 leases, includingthose that we believe will be extended in 2005, would be eligible for automaticextension if Wal-Mart converts the locations to Supercenters before therespective lease terms expire.  Wetypically receive notice of no more than one year’s schedule of pendingSupercenter conversions.  Based oninformation presently available, we believe that the lease terms for as many asnine of our vision centers could be extended during 2005 as a result ofconversions.  The average age of thesevision centers will be ten years and six months at the anticipated date ofconversion.  We can provide no assurancethat any other lease we have with Wal-Mart will be extended in the future.

 

We accordingly believethat if we exercise all available renewal options, we will still be operatingvision centers inside 129 domestic Wal-Mart stores at the end of 2009.

 

We do not always exerciseour renewal option on our domestic Wal-Mart stores, usually because ofunattractive store economics associated with a higher minimum rent obligation duringthe renewal term.  Through February 28,2005, we have had 266 opportunities to exercise our three-year renewal optionand have exercised the option 252 times. We can provide no assurance that this historical ratio will help predictour future decisions regarding renewal options, as such decisions are made onan individual store basis considering then-current facts and circumstances.

 

***Wal-Mart de Mexico.*** Our agreementwith Wal-Mart de Mexico provides for a five-year base term at each location,followed by two options for two-year renewals and a final option for anadditional one-year renewal.  Theagreement also provides for early lease termination by either party for visioncenters that fail to achieve certain minimum sales levels for four consecutivequarters.  In the third quarter of 2004and the first quarter of 2005, we closed two and four vision centers,respectively, under this provision.

** **

**Our agreement with Wal-Mart deMexico provides that each party will not deal with other parties to operate leaseddepartment vision centers in Mexico.  Weare continuing negotiations with Wal-Mart de Mexico that could, among othermatters being discussed, eliminate or modify this provision.  During our negotiations, the lease terms of12 of our vision centers in Mexico have expired.  We continue to operate all 12 on amonth-to-month basis.  These 12 locationsare included in 2005 lease expirations in the table set forth above.**

** **

***Fred Meyer.*** All stores that we operateinside Fred Meyer locations are governed by a lease agreement that expiresDecember 31, 2006.  Although that date isthe first day of our 2007 fiscal year, we have included all 47 locations in the2006 lease expiration column in the schedule set forth above.  We believe that we have an excellent relationshipwith this host; accordingly, we currently believe that we will be able to enterinto an agreement to continue operating some or all of these stores after thecurrent lease expires, although we cannot provide assurance that this will bethe case or that any extension will be on the terms and conditions contained inour current lease agreement.

** **

***Military.*** Contracts for operatingindividual vision centers on U.S. military bases are awarded as a result of acompetitive bidding process.  At the endof the lease term, a new bidding process occurs.  Prior to 2004, contracts for each locationgenerally provided for a lease term of between two and five years.  Commencing in 2004, contracts awarded forvision centers provide for a seven-year lease term.  In 2004, we won six bids for new locationsand also won an additional bid to continue operating an existing location.  In 2005 we won a bid to continue operatinganother existing location. We intend to continue to vigorously pursue expansionof our vision center operations on military bases.

** **

***Other Operations.*** The leasesfor the two home medical equipment stores we operate inside Wal-Mart providefor a five-year base term followed by a five-year renewal at our option.  The base term of both leases will expire in2009.  The leases provide that we maycancel them, upon three-months’ advance notice, at any time between the twelfthand eighteenth month of the base term. On February 28, 2005, we notified Wal-Mart of our intention to terminateboth leases during this early termination period.

** **

#### **Liquidity and Capital Resources**

#### ** **

We have generatedsubstantial positive operating cash flow since we emerged from bankruptcy onMay 31, 2001.  Operating

 

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cash flow has beensufficient to fund our capital expenditures. We have used our excess cash to reduce the balance of the SeniorSubordinated Notes by more than $47 million, through mandatory principalredemption payments made each February and August at par and through periodicrepurchases made at discounted prices.

 

We made mandatoryprincipal redemption payments on the Notes of $545,000 on February 28, 2004 andapproximately $2.0 million on August 31, 2004. Subsequent to the end of fiscal 2004, we made a mandatory principalredemption payment on the Notes of approximately $4.9 million on February 28,2005.  These redemptions are based on therequirements of the indenture and are made at par.  Each principal redemption payment is based onthe results for the six-month period ending in the preceding June or December,respectively.  Following the February 28,2005 payment, the remaining outstanding principal balance on these Notes was$72.9 million.  Our ability to developsuccessful businesses to replace the reductions in revenue that will resultfrom our declining store count will have a significant impact on our ability toretire all of this debt by its March 2009 due date.  However, the mandatory redemption provisionsof the Note Indenture may reduce the amount of cash we have available to investin replacement businesses.  See “RiskFactors - Loss of high-volume Wal-Mart stores could adversely affect ourfinancial health”, “Risk Factors - Our substantial indebtedness could adverselyaffect our financial health” and see “Risk Factors - We are required by ourindenture to make mandatory redemptions of principal owing on our Notes if wegenerate excess cash flow, which may have an adverse impact on our commonstock.”

 

To meet occasional needsfor additional funding, we currently maintain a $10 million revolving creditfacility with Fleet Retail Group, Inc. Our most recent borrowings under this facility occurred in April 2003,when large periodic payments were made under several contractualarrangements.  A portion of the Fleetfacility may be used to issue letters of credit.  At February 28, 2005, we had no borrowingsunder our credit facility, we had letters of credit of $4.0 million outstandingand our unused availability was approximately 2.5 million.  Availability under the facility is subject toborrowing base and related limitations. The Fleet credit facility expires onMay 30, 2007.

 

As amended to date, ourFleet facility contains various restrictive covenants, including requirementsthat we:

 

•                  maintainminimum EBITDA (as defined) of $19.6 million for each rolling 12-month periodending on the last day of each fiscal month,

•                  maintain a minimum fixed chargecoverage ratio (as defined) of 1.0 to 1.0 for each six-month period endingnearest June 30 and December 31,

•                  limit our annual lease obligations innon-hosted locations, and

•                  limitour capital expenditures.

 

In March 2005, to allowfor the opening of new freestanding locations, Fleet increased the limit on certainnon-host lease obligations from $800,000 during any consecutive twelve-monthperiod to $2,000,000 during any consecutive twelve-month period and providedfor capital expenditures of up to $9.5 million in 2005.  The capital spending limit will revert to itsprevious level of $5.5 million after 2005. If our test of freestanding vision centers is successful and we wish tocontinue opening additional freestanding locations, we may have to seekadditional amendments of these and possibly other covenants under thisarrangement.  We cannot offer anyassurances that, if needed, Fleet would increase the annual lease payment orcapital spending limits to accommodate an accelerated pace of store openings.

 

We continually monitorour compliance with covenants under the Fleet agreement and believe that wecurrently comply with all such covenants. We particularly focus on adjusted EBITDA (as defined under our debtagreements) because this measure is also a component of the computations wemake each six months to determine the amount of our mandatory redemption of ourSenior Subordinated Notes.

 

The following is areconciliation of net earnings to adjusted EBITDA as defined (amounts inthousands):

 

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| ** **                                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                   |       |     |       |     |       |     |       |
| Net earnings (loss)                                    |       | $        | 12,375     |     | $          | (3,868   | )          | $ | (6,204 | ) |
| Adjustments:                                           |       |     |       |     |       |     |       |
| Interest expense                                       |       | 10,595   |       | 12,913   |       | 14,099   |       |
| Income tax expense (benefit)                           |       | (787     | )          | 198      |       |     |       |
| Depreciation and amortization                          |       | 13,542   |       | 15,962   |       | 18,999   |       |
| Cumulative effect of a change in accounting  principle |       |     |       | 564      |       |     |       |
| Gains on repurchase of Senior Subordinated Notes       |       | (3,166   | )          | (2,321   | )          | (1,566   | )          |
| Impairment of long-lived assets                        |       | 336      |       | 550      |       |     |       |
| Other                                                  |       | (63      | )          | 66       |       | (470     | )          |
| Adjusted EBITDA, as defined                            |       | $        | 32,832     |     | $          | 24,064   |       | $ | 24,858 |   |

 

adjusted EBITDA does notrepresent cash flow from operations as defined by generally accepted accountingprinciples, is not necessarily indicative of cash available to fund all capitalexpenditures, debt service costs and payment of income taxes, should not beconsidered an alternative to net income or to cash flow from operations (asdetermined in accordance with GAAP) and should not be considered an indicationof our operating performance or as a measure of liquidity.  EBITDA is not necessarily comparable tosimilarly titled measures for other companies.

 

The Company’s capitalexpenditures have historically been for store openings, relocations, andremodeling, lensmaking and other optometric equipment. In 2005, we expect toopen between 12 and 18 new freestanding stores. Capital costs for the two freestanding stores we opened in 2004 averaged$200,000 per store.  We have already beenawarded contracts to operate three new military vision centers and we intend tobid on several other locations as the current contracts expire.  Capital costs for the six new militarylocations we opened during 2004 averaged $71,000 per store.    In 2005, we expect to refixture nine of ourWal-Mart vision centers at the time their lease is extended because Wal-Martconverts the store to a Supercenter. Capital costs for the 15 vision centers affected by Wal-Mart’s 2004conversions averaged $34,000 per store.

 

We expect that cash flowgenerated by 2005 operations will be sufficient to fund debt service costs andthe capital costs associated with new store openings.  It is possible that our capital spending for2005 could approach the $9.5 million limit provided under our agreement withFleet.

 

Although we expect torecord an income tax provision in 2005, at a rate of 36% to 40% of pre-taxincome, we do not anticipate that our actual obligations to pay income taxeswill increase from 2004’s rate of less than 5% of pre-tax income because of ourability to utilize net operating tax loss carryforwards to offset our regularfederal tax liability and substantially all of our state tax liabilities.  Our usable federal net operating losscarryforward is approximately $61.1 million at January 1, 2005.  Available state net operating losscarryforwards vary by jurisdiction.  Manyof these tax losses, particularly the federal loss carryforward, are subject tosignificant limitations in certain circumstances.  See “Risk Factors - Our use of net operatingloss carry-forwards may be subject to limitations.”

 

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#### **Future Commitments**

#### ** **

The table below setsforth our contractual obligations as of January 1, 2005 (amounts in thousands):

 
| ** **                      | ** ** | **Payments due by fiscal year** | ** ** |
|---------------------------------|------------|---------------------------------|------------|
| ** **                      | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **There-  after** | ** ** | **Total** | ** ** |
|                            |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Senior Subordinated Notes (a)   |       | $                               | 4,858      |   |   |   |   |   |   |   | $ | 72,930 |   |   |   | $ | 77,788 |   |
|                            |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest expense (a)            |       | $                               | 8,847      |   | $ | 8,750 |   | $ | 8,750 |   | $ | 8,750 |   | $ | 2,187 |   |   |   | $ | 37,284 |   |
|                            |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating lease obligations (b) |       | $                               | 21,040     |   | $ | 16,467 |   | $ | 9,921 |   | $ | 5,451 |   | $ | 3,540 |   | $ | 6,344 |   | $ | 62,763 |   |
|                            |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Purchase obligations (c)        |       | $                               | 204        |   | $ | 120 |   | $ | 20 |   |   |   |   |   |   |   | $ | 344 |   |
|                                 |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(a)          Oursenior subordinated debt agreement provides for semi-annual principalrepayments in August and February based in part on the results of operationsfor the six-month periods ended in the preceding June and December.  The timing of future principal repayments iscontingent upon future results. Accordingly, except for the payment that was made on February 28, 2005,the total carrying value is presented as due upon maturity in 2009, and theassociated interest obligation is computed on the same basis.

 

(b)         Our operating leaseobligations represent minimum rent payments due under our various leaseagreements for retail space, HMO offices and operating equipment.  The rent for certain of our retail locationsis based on a percentage of sales.  The amountsin the above table do not include any amounts for these locations.

 

(c)          Our purchase obligationsrepresent minimum purchase requirements for local phone and certain other dataservices including polling and internet capability.

 

(d)         We have outstandingletters of credit in the amount of $4,028,000 which expire in 2005.  As no payments are expected to be made underthese letters of credit, the letter of credit amounts are not included in theabove table.

 

#### **Inflation**

#### ** **

Although we cannotdetermine the precise effects of inflation, we do not believe inflation has hada material effect on our domestic sales or results of operations.  We cannot determine whether inflation willhave a material long-term effect on our sales or results of operations.

 

As a result of inflationin prior years, we have in the past adjusted our retail pricing.  Further pricing adjustments are contingentupon competitive pricing levels in the marketplace.  Management is monitoring the continuingimpact of these inflationary trends.

 

**CriticalAccounting Policies and Estimates**

 

Our consolidatedfinancial statements, as discussed under Management’s Discussion and Analysisof Financial Condition and Results of Operations, have been prepared inaccordance with accounting principles generally accepted in the UnitedStates.  The preparation of thesefinancial statements requires that we make estimates and assumptions thataffect the reported amounts of assets and liabilities and the disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.

 

On an ongoing basis, weevaluate our estimates and judgments, and incorporate any changes in suchestimates and judgments into the accounting records underlying our consolidatedfinancial statements.  We base ourestimates and judgments on historical experience and on various other factorsthat we believe to be reasonable under the circumstances, the results of whichform the basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources.  Actual results may differ from theseestimates under different assumptions or conditions.

 

We have identified thepolicies below as critical to our business operations and the understanding ofour results of operations.  The impactand any associated risks related to these policies on our business operationsis discussed throughout Management’s Discussion and Analysis of FinancialCondition and Results of Operations where such policies affect our reported andexpected financial results.  (For adetailed discussion on the application of these and other accounting policies,

 

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see Note 2 in the Notesto Consolidated Financial Statements.)

 

***Revenue Recognition.* **We defer revenue recognition untildelivery of the product by estimating the value of transactions for which finaldelivery to the customer has not occurred at the end of the periodpresented.  The amount of cash that wasreceived at the time the customer’s order was placed is recorded as a depositliability and is included in accrued liabilities.

 

We currently sellseparately priced extended warranty contracts, generally with terms of twelvemonths.  Revenues from the sale of thesecontracts are deferred and amortized over the life of the contract on astraight-line basis.  The costs toservice the warranty claims are expensed as incurred.  These warranty contracts currently generate apositive profit margin.  However, if theutilization rates of these warranties increased significantly, the repair andreplacement expense could exceed the sales price of these warranties.  If that became the case, we would record afuture liability for anticipated warranty claims at the time of sale, insteadof expensing the warranty claims as incurred.

 

Revenue is earned fromHMO memberships and services.  Revenuefrom membership premiums is recognized over the twelve-month life of the policyas services are rendered and revenue from related managed care services isrecognized as  such services arerendered.

 

We must make estimates ofpotential returns and replacements of all or part of the eyewear sold to acustomer.  We analyze historical remakeand warranty activity, consider current economic trends and changes in customerdemand and acceptance of our products when evaluating the adequacy of ourestimate of these costs.  If we madedifferent judgments or utilized different estimates, this would likely resultin differences in the amount and timing of revenue and related costs for anyperiod.

 

***Allowance for Uncollectible Managed Care Receivables.* **Managed care accounts receivable arerecorded net of contractual allowances and reduced by an allowance for amountsthat may become uncollectible in the future. A significant portion of our receivables are due from health care plansor third-party administrators located throughout the United States.  Approximately 11% of our 2004 net salesrelated to products sold to customers that ultimately will be funded in full orin part through private insurance plans, third party insurance administrationprograms or government reimbursement programs such as Medicare andMedicaid.  Any failure on our part toaccurately and timely file for reimbursement with these programs can have anadverse effect on our collection results which, in turn, will have an adverseeffect on liquidity and profitability.

 

Estimates of ourallowance for uncollectible receivables are based on our historical billing andcollection experience.  Changes in ourbilling and collection processes, changes in funding policies by insuranceplans and changes in our sales mix within insurance plans may have a materialeffect on the amount and timing of our estimated expense requirements.

 

***Inventory Valuation*. **Our inventories are stated at the lowerof weighted average cost or market.

 

In most cases, theexpected sales value (i.e., market value) of our inventory is higher than itscost.  However, as we strategicallychange our frame and lens selection from time to time, discontinued merchandisemay be removed from stores and returned to the distribution center or it may bemarked as promotional merchandise and sold at a lower price.  There is a high degree of judgment andcomplexity in determining the market value of such inventories.  For inventory on hand, we estimate the futureselling price of our merchandise, given its current selling price and plannedpromotional activities, and provide a reserve for the difference between costand the expected selling price for all items expected to be sold below cost.

 

At the beginningof fiscal 2003, we adopted Emerging Issues Task Force Issue No. 02-16, “Accountingby a Customer for Certain Consideration Received from a Vendor” (“EITF 02-16”).  As a result of the adoption of EITF 02-16,certain vendor allowances are now presented as a reduction of inventory costand subsequently as a component of cost of goods sold.

 

We conductphysical inventory counts for all of our store locations at least twice peryear and adjust our records to reflect the actual inventory counts.  Cycle counts are performed weekly forinventory in our distribution centers and laboratory facilities, and allinventory in our distribution centers and laboratory facilities is counted nearthe end of the fiscal year.  As alllocations are not counted as of our reporting dates, we provide a reserve forinventory shrinkage based principally on historical inventory shrinkageexperience.

 

***Valuation of Long-Lived and Intangible Assets. ***Our most significantintangible asset is the Intangible Value of Contractual Rights, which wasestablished as part of our adoption of fresh start accounting in May 2001 andrepresents the value of our lease agreement with Wal-Mart and the businessrelationship therein created.  Thisintangible asset has a net value of $85.8 million at January 1, 2005.  The precise length of this intangible asset’slife is not known due primarily to Wal-Mart Supercenter conversions thatautomatically trigger extensions on the contractual life of the asset.  Based on our projections,

 

28

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our best estimate of theuseful life of this asset was fifteen years at inception and is 11 years and 5months at January 1, 2005.  Due to theuncertainty involved in predicting the pattern of economic benefits realizedfrom the Wal-Mart relationship, we amortize this asset using the straight-linemethod.

 

We assess the impairmentof all identifiable intangibles and long-lived assets on an annual basis andwhenever events or changes in circumstances indicate that the carrying valuemay not be recoverable.  Factors we considerimportant, which could trigger an impairment review, include (1) actual orbudgeted operating losses at vision center locations; (2) a significantunderperformance of vision center operations relative to expected historical orprojected future operating results; (3) significant changes in the manner ofour use of our assets or the strategy for our overall retail optical business;(4) significant negative industry or economic trends; (5) a significant declineor adverse change in the rate or geographic concentration of Wal-Mart hoststore relocations or Supercenter conversions; and (6) a permanent adversechange in cash flows generated by an operation.

 

If one or more of theabove indicators of impairment exists, we determine if the carrying value ofintangibles or long-lived assets may not be recoverable based on a projectedcash flow model.  If the projected cashflows are not in excess of the book value of the related asset, we measure theimpairment based on a projected discounted cash flow method.  In accordance with this policy, we recordedimpairment charges of $336,000 and $550,000 in 2004 and 2003, respectively, towrite down the value of long-lived assets at under-performing stores to theirfair market value.

 

Significant managementjudgment is required regarding the existence of impairment indicators asdiscussed above. Future events could cause us to conclude that impairmentindicators exist and that long-lived assets or intangible assets areimpaired.  Any resulting impairment losscould have a material adverse impact on our financial condition and results ofoperations.

 

***Accounting for Income Taxes. ***As part of the process of preparing ourconsolidated financial statements we are required to estimate our income taxesin each of the jurisdictions in which we operate.  This process involves estimating our actualcurrent tax exposure together with assessing temporary differences resultingfrom differing treatment of items, such as equipment depreciation, for tax andaccounting purposes.  These differencesresult in deferred tax assets and liabilities. Prior to 2002, we incurredsignificant net operating losses that resulted in tax net operating loss (“NOL”)carry-forwards.  These NOLs also resultin a deferred tax asset to the extent they could be utilized to reduce taxesotherwise due in the future.

 

We must assess thelikelihood that our deferred tax assets will be recovered from future taxableincome.  To the extent we believe that itis “more likely than not” that recovery will not occur, we must establish avaluation allowance.  If we establish orincrease a valuation allowance in a period, we must include an expense withinthe tax provision in the statement of operations.  If we reduce a valuation allowance during aperiod, income tax expense will be reduced by the amount of such reduction.

 

Since emerging frombankruptcy, our 2002, 2003 and 2004 year-end deferred tax assets have exceededour year-end deferred tax liabilities. At the end of both 2002 and 2003, we recorded a valuation allowanceagainst the net deferred income tax asset. The amount of the valuation allowance was sufficient to reduce thedeferred tax asset to an amount equal to the deferred tax liability, resultingin no net deferred tax balance. At January 1, 2005, total deferred tax assetsexceeded total deferred tax liabilities by $1.2 million.  At January 1, 2005, we reversed the valuationallowance that had been recorded in previous years against this net deferredincome tax asset, because we were no longer able to conclude that it was “morelikely than not” that the net deferred tax asset would not be realized.  This conclusion was based upon thesubstantial improvement we achieved in 2004 operating results, expected futureprofitability from continuing operations and other factors.

 

***Self-Insurance Accruals*. **We self-insure estimated costs associatedwith workers’ compensation claims and group medical liabilities, up to certainlimits.  Insurance reserves areestablished based on actuarial estimates of the loss that we will ultimatelyincur on reported claims, as well as estimates of claims that have beenincurred but not yet reported.  Trends inactual experience are a significant factor in the determination of suchreserves.  We believe our estimatedreserves for such claims are adequate, however actual experience in claimfrequency and/or severity could materially differ from our estimates and affectour results of operations.

 

***Other Accounting Policies. ***The above listing is not intended to be acomprehensive list of all of our accounting policies.  In many cases, the accounting treatment of aparticular transaction is specifically dictated by generally acceptedaccounting principles.  See the notes toour audited consolidated financial statements which begin on page F-7 of thisAnnual Report on Form 10-K and contain accounting policies and otherdisclosures required by generally accepted accounting principles.

 

***Recent Accounting Pronouncements. ***See Note 3, “RecentAccounting Pronouncements,” included in the “Notes to Consolidated FinancialStatements” that begin on page F-7 of this Annual Report on Form 10-K.

 

29

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**RiskFactors**

 

An investment in NationalVision will be subject to significant risks, some of which are inherent in theretail optical business, some of which are due to the Company’s businessrelationship with Wal-Mart and some of which are general legal or businessrisks.  Investors should carefullyconsider the risks and uncertainties described below and elsewhere in thisAnnual Report on Form 10-K.

 

***Our ability to continue to generate revenue and operatingincome depends on our******continued relationship with Wal-Mart.***

 

We are substantiallydependent on Wal-Mart and its affiliates for our current operations.  The following chart shows, as of January 1,2005, the number of our vision centers that are in Wal-Mart stores and thetotal number of our vision centers:

 
| **Category**                 | ** ** | **Number** | ** ** |
|------------------------------|------------|------------|------------|
|                         |       |       |       |
| Total Vision Centers         |       | 416        |       |
| Domestic Wal-Mart Locations  |       | 304        |       |
| Wal-Mart de Mexico Locations |       | 35         |       |

 

Our vision centerslocated in Wal-Mart stores have historically accounted for a substantialportion of our net revenues and operating cash flow.  Vision centers in Wal-Mart stores relylargely on customer traffic generated by the Wal-Mart host store.

 

Wal-Mart is under noobligation to provide us with additional vision center leases.  We have no basis to believe that Wal-Martwill offer us any additional locations. We also have no basis to believe that Wal-Mart will offer to extend anyof our existing leases apart from instances where Wal-Mart is obligated to doso pursuant to the terms of our master license agreement upon the relocation orconversion of a store to a Supercenter (see “Management’s Discussion andAnalysis of Financial Condition and Results of Operations - Lease Agreements”).  We will therefore need to replace our salesand operating earnings generated from our Wal-Mart vision centers with salesand operating earnings generated from new business opportunities, which aresubject to significant risk and uncertainty (see “Our new businessopportunities are unproven”).

 

***Loss of high-volume Wal-Mart stores could adversely affectour financial health.***

 

Average annual revenuesin our domestic Wal-Mart vision centers were approximately $614,000 forlocations that operated throughout fiscal 2004. Average annual revenues in our other vision centers that we continue toown were less than $298,000 in the same period. The expiration of our leases with Wal-Mart will cause a reduction in ourrevenues that we may not be able to replace with revenues generated by othervision centers or by other lines of business we are exploring.  We expect that our expenses, however, willincrease over time.  A combination oflower sales and higher expenses would adversely affect our ability to repay orrefinance our Notes, which could have an adverse effect on the price of ourcommon stock.

 

In addition, in each ofthe next several years, the base terms of a number of leases for vision centersunder our Wal-Mart agreement will expire. Our rental obligations to Wal-Mart will increase in the three-yearoption period.  We will need to continueto improve sales at these vision centers. If we do not, our rent as a percent of sales will increase significantlyduring the option period for each of these vision centers.  Alternatively, we may choose not to exercisethe extension options.

 

***Our financial performance may be adversely affected by salesrecorded at vision******centers scheduled to close under the******Wal-Martagreement.***

 

We have observed sharpdeclines in sales levels as our vision centers come to the end of their leaseterm under the Wal-Mart agreement.  Weexpect to close 34 Wal-Mart vision centers in each of fiscal 2005 and fiscal2006.  In the months prior to theirscheduled date of closure, we expect these vision centers to record substantialsales declines.  The extent of the salesdeclines, coupled with the number of vision centers nearing the end of theirlease term, could have a negative impact on our sales and our profitability.

 

***Our declining base of vision centers in Wal-Mart storescould make it more******difficult for us to compete.***

 

We expect that the numberof our vision centers in Wal-Mart stores will substantially decrease over thenext several years.  A declining base ofvision centers, coupled with a decline in cash flow, could impair our ability

 

•             toattract and retain management and retail associates

 

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•             tocompete for managed care contracts

 

•             toobtain favorable terms, such as discounts and rebates, from optical vendors

 

•             toenter into other business arrangements

 

•             togenerate cash to fund other business opportunities.

 

***Our substantial indebtedness could adversely affect ourfinancial health.***

 

As a result of theissuance of our 12% Notes due March 2009, we are highly leveraged.  The Notes are subordinated to our creditfacility.  As of February 28, 2005, wehad outstanding:

 

•             totalindebtedness of $72.9 million represented by the Notes, and

 

•             totalavailability of $2.5 million under our credit facility, after letter of creditrequirements.

 

Our ability to pay orrefinance our indebtedness, including our ability to repay the Notes, or tofund capital expenditures will depend on our future performance.  To a certain extent, our performance issubject to general economic, financial, competitive, legislative, regulatoryand other factors that are beyond our control.

 

We cannot assure you thatour business will generate sufficient cash flow from operations, that revenuegrowth will be realized or that future borrowings will be available under ourcredit facility in an amount sufficient to enable us to pay our indebtedness,including the Notes, or to fund our other liquidity needs.

 

Our substantialindebtedness could have important consequences. For example, it could:

 

•             makeit more difficult for us to satisfy our obligations under the Notes, includingour ability to pay off the Notes at maturity;

 

•             increaseour vulnerability to general adverse economic and industry conditions;

 

•             limitour ability to obtain additional financing to fund future working capital,capital expenditures, new business opportunities, and other general corporaterequirements;

 

•             requireus to dedicate a substantial portion of our cash flow from operations to thepayment of our indebtedness, thereby reducing the availability of our cash flowto fund working capital, capital expenditures, new business opportunities, orother general corporate requirements;

 

•             limitour flexibility in planning for, or reacting to, changes in our business andour industry;

 

•             placeus at a competitive disadvantage compared to competitors that have less debt;and

 

•             limit,along with the financial and other restrictive covenants in our indenture andcredit facility, our ability to borrow additional funds.

 

Our failure to complywith the covenants in the indenture under which our Notes were issued or in ourcredit facility would result in an event of default which, if not cured orwaived, could have a material adverse effect on us.

 

***We may not successfully implement any strategicalternatives.***

 

As part of our review of ourstrategic alternatives, we have reviewed, and expect to continue to review,strategic business transactions.  We maybe unable to implement any such transactions. For example, competitors, governmental regulation, and developments inour industry may disrupt our review and implementation of strategicalternatives.  In addition, we may faceadditional risks and uncertainties following a transaction such as an acquisitionor a recapitalization, including (i) difficulty in integrating an acquiredbusiness in an efficient and effective manner; (ii) inability to achievestrategic objectives, cost savings and other benefits; (iii) the lack ofsuccess by an acquired business in its markets; (iv) the loss of keyemployees; (v) the diversion of the attention of senior management fromour operations; (vi) liabilities that were not

 

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known at the time of anacquisition or the creation of accounting or tax issues, including the possibleloss of tax NOL carry-forward credits; (vii) operating and other constraintsarising out of loan or other covenants; and (viii) the triggering of a requiredredemption of Notes under certain forms of change in control.  If we fail to timely recognize or addressthese matters or to devote adequate resources to them, we may fail to achieveour strategic goals.

 

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***Our new business opportunities are unproven.***

 

We are currentlyexploring three different business opportunities: opening free-standing visioncenters in market areas where the lease for our Wal-Mart vision center hasexpired; opening vision centers in hosts other than Wal-Mart; and openingoptometric offices in California. There are risks associated with each of theseopportunities.

 

Free-Standing Vision Centers

 

As of January 1,2005, we have opened two vision centers in strip shopping centers.  We plan to open 12 to 18 additional such visioncenters in 2005.   We do not know whetherthese vision centers will be profitable.  In addition, the following risks anduncertainties could affect the outcome of this test:

 

•                  We may be unable to locate suitablereal estate;

•                  We may be unable to retain theemployees and the optometrists from our closed Wal-Mart vision center;

•                  We may be unable to transfer thegoodwill from our closed location to the new one;

•                  We may incur substantial costs foradvertising and marketing the new locations.

 

# *Other Host Operations*

# * *

We continue toconsider opening vision centers in hosts other than Wal-Mart. We do not knowwhether we will in fact open in another host. In addition, operations inanother host environment would be subject to the following risks and uncertainties:

 

•                  The lease or other arrangement mayhave high occupancy charges or other onerous terms;

•                  A different host environment wouldlikely not generate the same level of customer traffic from which our Wal-Martvision centers benefit.

 

# *Optometric Vision Centers*

# * *

As of January 1,2005, our HMO subsidiary in California has opened 23 optometric officesadjacent to vision centers operated by Wal-Mart in that State and expects toopen more such locations in the future. There are risks that:

 

•                  These locations will be unprofitableand drain cash and management resources;

•                  We could incur additional costsbecause regulatory and other authorities may seek to challenge our operations.

 

We also do not know the number of offices oursubsidiary will open pursuant to this arrangement. The opening of offices incertain geographic locations could be subject to regulatory approval, whichcould also increase costs and cause delays.

 

General

 

We may have insufficient capital to implement ourexpansion plans (see “Our substantial indebtedness could adversely affect ourfinancial health” and “We are required by our indenture to make mandatoryredemptions of principal owing on our Notes if we generate excess cash flow,which may have an adverse impact on our common stock”).  In addition, the anticipated run-off of ourleases with Wal-Mart will require us to explore and develop these plans in thenear term.  There is also the risk that,in exploring these plans, management will devote less attention to our corebusiness of operating vision centers in Wal-Mart and that the core businesswill be adversely affected.

 

***Our pursuit of other lines of business could be constrainedby the terms of our******indenture.***

 

The indenture governingour Senior Subordinated Notes limits our operations to those which are “thesame, similar or reasonably related to the businesses in which” we were engagedas of the date we emerged from bankruptcy. We tested unsuccessfully the concept of operating home medical equipmentcenters in Wal-Mart stores.  We are alsoinvestigating other concepts.  Ourindenture could limit our ability to invest in these other lines of businessand, generally, could limit our ability to pursue these lines of business.  In addition, certain holders of our Noteshave previously objected to our engaging in other lines of business.  Although we believe that we are in compliancewith the indenture and intend to continue to comply with the indenture, we cangive no assurance that these holders might not seek to declare a defaultarising out of our engaging in these lines of business.

 

***Because our optical laboratories and distribution centerprovide substantially******all the eyeglasses and related products we sell at ourretail locations, we****depend ontheir regular and efficient operation, and any disruption could have****a severe***

 

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***adverse impact on our retail business.***

 

Our manufacturing anddistribution center operations are subject to various risks.

 

Our two central opticallabs and distribution centers are located in Lawrenceville, Georgia and St.Cloud, Minnesota.  A fire, flood,earthquake, war, work stoppage, supply shortage or disruption, adversegovernment action or other disaster or condition at either location couldresult in a loss of production capabilities and, accordingly, adversely affectour ability to service our retail locations.

 

We depend on a smallnumber of suppliers for raw materials. Most of the raw materials used in our products are readily availablefrom multiple suppliers at competitive prices, and we have not experienced anysignificant shortages of raw materials. The loss of any of our current suppliers, or a significant decrease inthe supply of the raw materials, would require us to obtain these raw materialselsewhere.  If we were unable to obtainthe materials from other suppliers at acceptable prices, our gross margins andour ability to continue our everyday low price strategy within Wal-Mart couldbe adversely affected.  In addition, athird party processes our photochromic lenses using its proprietarytechnology.  We therefore rely on thisparty for our production of these lenses.

 

We may be adverselyaffected by environmental and safety regulations to which we are subject**. **Wemust comply with environmental laws and regulations concerning emissions to theair, waste water discharges and the generation, handling, storage,transportation and disposal of hazardous wastes, and with other federal, stateand local laws and regulations.  Wecannot assure you that we will operate at all times in complete compliance withall such requirements.  We could besubject to potentially significant fines and penalties for any noncompliancethat may occur.  We cannot predictaccurately the potential impact of these laws and regulations on us in thefuture.

 

Our manufacturingoperations depend in part on our ability to attract and retain personnel withrelevant industry experience.  The lossof the services of this personnel or the ability to retain such personnel inthe future could have an adverse impact on our manufacturing operations.

 

The efficiency of ourmanufacturing operations is an essential component of our everyday low priceretail strategy.  We must continuallycontrol our product manufacturing costs and operating expenses.  We may not be able to continually controlthese costs and expenses.  For example,rising oil prices will increase our transportation costs.  To the extent that we do not control thesecosts and expenses, the ability of our retail locations to compete may beadversely affected.

 

***Military actionabroad could have a negative impact on our operations, particularly those onmilitary bases.***

 

As of January 1, 2005, we operate 28 vision centers onmilitary bases in the United States. We do not know the potential future impactof increased or diminished military action on these operations.

 

***Our use of net operating loss carry-forwards may be subjectto limitations.***

 

Prior to 2002, weincurred significant net operating losses. These losses resulted in significant tax net operating losscarry-forwards.  Our ability to utilizethe portion of our net operating losses that were incurred prior to ouremergence from Chapter 11 is limited under Section 382 of the Internal RevenueCode of 1986.  If our net operatinglosses incurred after our emergence from Chapter 11 also became subject tosubstantial limitation because of a future change of control of the Company orfor other reasons, our cash tax costs would increase and have an adverse effecton our ability to repay the Notes.  AtFebruary 28, 2005, 28.1% of our common shares are classified aschange-in-control shares under Section 382. A change in control is deemed to occur if this amount increases to over50%.  If, after such a change of control,we determined that we would be unable to utilize the net operating losses, wecould then be required to write down the related deferred tax asset and recorda charge against our financial results.  Certainof the transaction structures we are investigating as part of our strategicreview could possibly cause a change of control within the meaning of these taxlaws.

 

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***The right of holders of our Notes to receive payments isjunior to our******borrowings under our credit facility, which couldadversely affect our ability****topay off the Notes.***

 

Our indebtedness underour credit facility is secured by liens against substantially all of ourassets.  In the event of a default on oursecured indebtedness, or a bankruptcy, liquidation or reorganization of theCompany and our subsidiaries, these assets will be available to satisfyobligations with respect to this indebtedness before they can be used tosatisfy our obligations under our Notes.

 

***The terms of our credit facility and the indenture underwhich our Notes were******issued restrict our corporate activities.***

 

Our credit facilitycontains various restrictive covenants and requires us to maintain specifiedfinancial ratios and satisfy financial tests, such as a:

 

•             minimumrequirement of earnings before interest, taxes, depreciation and amortizationas defined in our credit facility of $19.6 million for each rolling 12-monthperiod ending on the last day of each fiscal month, and

 

•             minimumfixed charge coverage ratio of 1.0 to 1.0 for each six-month period endingnearest to June 30 and December 31.

 

Our ability to meet thesefinancial ratios and tests may be affected by events beyond our control, and wecannot assure you we will meet these tests. In addition, our credit facility and our indenture limit our ability totake action with respect to:

 

•             capitalexpenditures,

 

•             investments,

 

•             indebtedness,

 

•             liens,

 

•             dividends,

 

•             loans,

 

•             prepaymentsof other indebtedness,

 

•             mergers,acquisitions or sales of assets,

 

•             changesin business activities (see “Our pursuit of other lines of business could beconstrained by the terms of our indenture”),

 

•             transactionswith affiliates, and

 

•             issuanceof equity.

 

Our breach of any ofthese covenants could result in an event of default under our credit facility.  If a default occurs, our lender can declareour indebtedness, both principal and interest, immediately due and payable, andcould terminate its commitment to make future advances.  A default under the indenture could cause theprincipal and accrued interest on the Notes to become due and payable and wouldalso trigger a default under the credit facility.  The restrictions in the indenture and thecredit facility will likely restrict our ability to obtain additional financingfor working capital, capital expenditures or general corporate purposes.  We have pledged substantially all of ourassets under our credit facility and under the indenture.  If we fail to repay all amounts declared dueand payable, our lender and then the holders of our Notes could proceed againstthe collateral granted to them to satisfy our obligations.  It is likely that our assets would beinsufficient to repay in full that indebtedness and our other indebtedness,including the Notes.

 

***We are required by our indenture to make mandatoryredemptions of principal******owing on our Notes if we generate excess cashflow, which may have an adverse****impacton the price of our common stock.***

 

The indenture requiresthat, subject to its terms, we make redemptions of principal out of the excesscash flow that we may

 

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generate biannually.  There can be no assurances that we willgenerate enough excess cash flow to make any mandatory redemptions.  Prepayments of principal on the Notes, ifany, will prevent us from having excess cash to reinvest in our business, andcould adversely affect the price of our common stock.

 

***Holders of our common stock and our notes may elect to selllarge blocks of******common stock or notes, which may have an adverse effecton the price of our****common stockand our notes.***

 

Our former unsecuredcreditors received our common stock and our notes in exchange for their claimsagainst us.  Some or all of the holdersof our common stock and notes may prefer to liquidate their investment ratherthan hold the securities on a long-term basis. The possibility that one or more of the holders of significant numbersof shares of our common stock or a large principal amount of our notes maydetermine to sell all or a large portion of their shares of our common stock ortheir notes in a short period of time may adversely affect the market price ofthe common stock or notes.  Partially forthat reason, there can be no assurance as to the degree of price volatility inany trading market that may develop for the common stock and the notes.  As a result, no assurance can be given thatany holder of our common stock or our notes will be able to sell them or atwhat price any sale may occur.  Noassurance can be given as to the market price, if any, that will prevail forour common stock in the future.  Ournotes may trade at prices higher or lower than their face value, depending uponmany factors, including, without limitation, the prevailing interest rates,markets for similar securities, industry conditions, and investor expectationsfor us and our performance.

 

***Our common stock may be delisted from the American StockExchange, if we do not******meet certain listing standards.***

 

The rules of the AmericanStock Exchange (“AMEX”) allow the exchange to delist securities if the AMEXdetermines that a company’s securities fail to meet guidelines with respect tocorporate net worth, public float, number of shareholders, the aggregate marketvalue of shares, or price per share.  Wecannot assure purchasers of our common stock or notes that we will continue tomeet the requirements of the AMEX.  If weare unable to continue to satisfy these criteria, the AMEX may begin proceduresto remove our common stock or notes from the exchange.  If our common stock or notes are delisted, atrading market may no longer exist, and the ability of shareholders and holdersof our notes to buy and sell common stock or notes may be materially impaired.

 

***We have not declared dividends in the past, and do notanticipate doing so in******the near future, which may adversely affectthe price of our common stock.***

 

Our credit facility andour indenture prohibit the payment of cash dividends without the consent of thelender and the holders of the majority of outstanding principal amounts underthe Notes, respectively.  We have neverdeclared or paid any dividend on our capital stock.  We do not anticipate paying any cashdividends in the foreseeable future.

 

***The retail eyecare industry is highly competitive.***

 

We compete with largenational retailers, such as LensCrafters and Pearle Vision Centers, and withnumerous regional and local firms. Independent optometrists, ophthalmologists, and opticians often providemany of the same goods and services we provide. The level and intensity of competition can vary dramatically dependingon the particular market.

 

We also compete formanaged care contracts, which can allow us to provide better service to ourmanaged care customers by filing claims directly with the payor and collectingonly the applicable co-pay amount from the customer.  Our declining base of vision centers mayadversely affect our ability to compete for managed care contracts.

 

Several of ourcompetitors have significantly greater financial resources than we do.  As a result, they may be able to engage inextensive and prolonged price promotions which may adversely affect ourbusiness.  They may also be able to spendmore than we do for advertising.  If we arenot able to maintain our market share of the retail optical industry, our businesswill suffer.  A decline in our earningscould adversely affect the price of our common stock and the notes, and ourability to repay the notes.

 

In 2004, Luxottica (theowner of LensCrafters) and Pearle National completed a merger pursuant to whichLuxottica purchased Pearle.  This mergercould have an adverse impact on our ability to compete for managed careaccounts and to participate as a provider under managed care arrangementssponsored by the affiliates of Luxottica or Pearle.   This merger may also have other effects onour retail business which we cannot now predict.

 

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***Federal and state governments extensively regulate thehealth care industry.***

 

Both federal and stategovernments extensively regulate the delivery of health care, includingrelationships among health care providers such as optometrists and eyewearproviders like us.  Many states prohibitbusiness corporations from practicing medicine or controlling the medicaljudgments or decisions of physicians. States often prohibit various financial arrangements, such as splittingfees with physicians.

 

The fraud and abuseprovisions of the Social Security Act and anti-kickback laws and regulationsadopted in many states prohibit soliciting, paying, receiving or offering anycompensation for making, or causing someone to make, referrals of patients,items or services in some circumstances. The Social Security Act also imposes significant penalties for false orimproper Medicare and Medicaid billings. Many states have adopted similar laws. We must also comply with federallaws such as the Health Insurance Portability and Accountability Act of 1996(which governs our participation in managed care programs and which alsorequires that we maintain the privacy of health information of our customers)and the Food and Drug Administration Act (which regulates medical devices suchas contact lenses).  In addition, theStark Self-Referral Law restricts referrals for Medicare or Medicaid coveredservices where the referring physician has a financial relationship with theservice provider.  In some cases, therental of space constitutes a financial relationship under this law.  Many states have adopted similarself-referral laws which are not limited to Medicare or Medicaid reimbursedservices.  Violations of these laws mayresult in substantial civil or criminal penalties, including double and treblecivil monetary penalties, and in the case of federal laws, exclusion from theMedicare and Medicaid programs.

 

A ruling that we haveviolated these laws could, for example, result in:

 

•             censure,

 

•             delicensingof optometrists,

 

•             civilor criminal penalties, including large civil monetary penalties,

 

•             invalidationor modification of our agreements with optometrists and opticians, or

 

•             anorder requiring us to change our business practices.

 

These consequences couldhave an adverse effect on our business. Also, changes in our relationships with independent optometrists andopticians could adversely affect our relationship with Wal-Mart or our otherhost stores.

 

***We are subject to state and local regulation of the visioncare industry.***

 

The dispensing ofprescription eyewear is regulated in most states in which we do business.  In addition, all states regulate the practiceof optometry and many states regulate the contracts and other arrangementsbetween optical firms and optometrists. Our failure to comply with these regulations can have severeconsequences, including the closure of retail outlets, possible breaches of ourlicense agreement with Wal-Mart, changes to our way of doing business, and theimposition of fines and penalties.

 

We are subject toincreased regulatory risk in the state of California.   Optometrists who practice adjacent to ourretail locations in California are providers to and subtenants or employees ofa subsidiary which is licensed as a single-service health maintenanceorganization.   This subsidiary alsoprovides optometric services adjacent to retail locations owned and operated byWal-Mart stores.  The subsidiary isregulated by the California Department of Managed Health Care.  Although we believe that our operations inCalifornia comply with applicable law, there are no assurances that theDepartment of Managed Health Care, the Attorney General, or another stateauthority will not seek to challenge our manner of doing business in thestate.  Such challenges could force us tochange the way we do business, to incur significant expense in litigation andcompliance efforts, and could have a material adverse impact on us.

 

In addition, in 2002 theCalifornia Attorney General filed a lawsuit against one of our competitors,alleging that their operations violated state law (see “Legal Proceedings”).  The case is expected to be argued in theCalifornia Supreme Court later in 2005.  Subsequently, a private entity named “Consumer Cause” filed a lawsuitagainst us alleging violations of state law similar to those alleged by theCalifornia Attorney General in its lawsuit against our competitor.   In 2003, a Court of Appeal in the state ofCalifornia held that our method of doing business in the state of Californiacomplies with applicable law.  There is,however, a risk that, if the California Supreme Court holds that the operationsof our competitor violates state law, the California Attorney General couldbegin proceedings against us, notwithstanding our prior successful result inthe

 

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Court of Appeal.  In addition, the regulatory and litigationrisk created by the pendency of the litigation by the attorney general couldhave an adverse impact on our business. The litigation is now pending before the California Supreme Court and aresolution is expected later in 2005.

 

Local ordinances (such aszoning requirements) can also impose significant burdens and costs ofcompliance.  Frequently, our competitorssit on state and local boards.  Our risksand costs of compliance are often increased as a result.  All of these matters could cause our businessto suffer, our ability to repay the notes to be adversely affected, and thetrading price of our common stock and notes to decline.

 

***The departure of key executives could adversely affect ourbusiness.***

 

We depend on thecontinuing efforts of our executive officers and senior management.  The departure of these individuals insignificant numbers could adversely affect our business and prospects if we areunable to attract and retain qualified replacements.  The run-off of our vision centers could makeit more difficult for us to attract and retain management.  We do not currently have employmentagreements with any personnel, including key executive officers andmanagement.  However, we offer ourexecutives and management bonus and stock-based incentives related to ourperformance.

 

***Failure to have vision care professionals available in ornear our vision******centers would adversely affect our ability to winmanaged care and host store****contracts,and could prevent us from operating in some states.***

 

Our business andmarketing strategies emphasize the availability of independent optometrists inclose proximity to our vision centers. Typically, we contract with at least one licensed optometrist to occupyspace in or adjacent to each of our stores. Additionally, our agreement with Wal-Mart contemplates that we will makeoptometrists available at least 48 hours per week if permitted by law.  In some markets it may be difficult for us toattract and retain optometrists if our vision centers generate low sales.  Historically, if there is no licensedoptometrist available to give eye exams, our retail business has suffered.

 

In some markets, it canbe difficult to hire or keep vision care professionals on staff in our visioncenters.  Failure to maintain a staff ofqualified vision care professionals may cause our customers to go elsewhere toprovide for their optical needs, which would have an adverse effect on ourbusiness.

 

Many states require thatlicensed opticians be present when eyeglasses or contact lenses are fitted ordispensed.  Any difficulties or delays insecuring the services of these professionals could adversely affect ourbusiness and our relationship with our host stores.  Consequences of difficulty or delay couldinclude termination of our host store licenses for those vision centers andimposition of legal sanctions against us, including closure of vision centerswithout licensed professionals.

 

***Future operational success could depend on our ability todevelop and maintain******relationships with managed vision care companies.***

 

A meaningful percentageof patients receive health care coverage through managed care payors.  Our future operational success could dependon our ability to negotiate contracts with health maintenance organizations, employergroups and other private third party payors. We cannot assure you that we will be able to establish or maintainsatisfactory relationships with managed care and other third party payors.  The run-off of our leases with Wal-Mart couldmake it more difficult for us to establish and maintain theserelationships.  In addition, many managedcare payors have existing provider structures in place that they may be unableor unwilling to change.  The merger ofour two largest competitors could present additional challenges to ourparticipation in managed care programs (see “The retail eyecare industry ishighly competitive”).  Our inability toenter into arrangements with managed care payors in the future could have amaterial adverse effect on our business.

 

We have established anetwork of optometrists and other providers located in or adjacent to ourstores in order to enhance our ability to contract with managed care payors forboth professional services and retail eyewear supplies.  In 2004, approximately 11% of our revenues werereceived from managed care payors. Managed care contracts include a variety of reimbursement methods, suchas fee for service or discounts.  Ourcontracts with managed care companies on the one hand, and with networks ofoptometrists and other providers on the other, are subject to federal and stateregulations, for example:

 

*InsuranceLicensure*. Most states impose strict licensure requirementson companies that engage in the business of insurance, including healthinsurance companies and health maintenance organizations.  Many licensing laws mandate strict financialand other requirements which we may not be able to meet, were we deemed to beengaging in the business of insurance. Additionally, the licensure process can be lengthy and time consuming.

 

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*AntitrustLaws*. A range of antitrust laws apply to us and our networkof optometrists.  These laws prohibitanti-competitive conduct, including price-fixing, concerted refusals to deal,and divisions of markets.  We cannotassure you that our operations will not be challenged on antitrust or othergrounds in the future.

 

***Proposed reforms may affect our earnings and may adverselyaffect our business.***

 

There have been numerousreform initiatives at the federal and state levels relating to the payment forand availability of healthcare services. We believe that these initiatives will continue for the foreseeablefuture.  If adopted, some of thesereforms could adversely affect our financial results, and may adversely affectour business.

 

***We rely on third parties to pay many of our customers’costs.***

 

A significant portion ofmedical care in the United States is funded by government and private insuranceprograms, such as Medicare, Medicaid and company-sponsored health insuranceplans.  More medical beneficiaries whoare significant consumers of eyecare services may enroll in managed careorganizations.  Governmental and privatethird-party payors try to contain medical costs by:

 

•             loweringreimbursements,

 

•             imposinguse restrictions and risk-based compensation arrangements,

 

•             redesigningbenefits, and

 

•             exploringmore cost-effective methods of health care delivery.

 

These cost containmentefforts may lead to limitations or reductions in reimbursement for eyecareservices, which would adversely affect our future sales.  Additionally, some reimbursement programsrequire us to collect payment from third party payors.  Our inability to fully collect reimbursableamounts could adversely affect cash flow generated from operations.

 

We depend on reliable andtimely reimbursement of claims we submit to third party payors.  There are risks we may not be paid on atimely basis, or that we will be paid at all. Some plans have complex forms to complete.  Sometimes our staff may incorrectly completeforms, delaying our reimbursement.  Thesedelays can hurt our cash flow and also force us to writeoff more of theseaccounts receivable.

 

***New advances may reduce the need for our products or allowother manufacturers******to produce eyewear at lower cost than we can.***

 

Technological advances inthe eyecare industry, such as new surgical procedures or medical devices, couldreduce the demand for our products. Corneal refractive surgical procedures such as laser surgery, radial-keratotomyand photo-refractive keratectomy may reduce the demand for our products.  The development of new drugs may have asimilar effect.  Technological advancessuch as wafer technology and lens casting may make our current lensmanufacturing method uncompetitive or obsolete. The number of individuals electing Lasik and similar surgical procedurescould significantly decrease demand for our goods and services.  These and other medical and technologicaladvances may have a material adverse effect on our operations.

 

***We have increasedour buying of optical goods from overseas.***

 

We import significant quantities of optical productsfrom foreign vendors. Our operations are therefore subject to a number ofrisks, including:

 

•                  We may be unable to return unsatisfactoryor defective goods for credit.

•                  We are subject to currency exchangerisk on future purchases of these products.

•                  These vendors may be unable todeliver goods to us on a timely basis.

 

***A prolonged economic downturn could have an adverse impact onus.***

 

We believe that aweakening economy may cause an increase in the period of time betweenrepurchases of our retail products by the average consumer, since customers maysee replacement purchases of eyeglasses and contact lenses as non-essential.  An extension of the repurchase cycle for ourretail products would reduce the number of sales of our retail products,thereby

 

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reducing our revenues.

 

***Operating in Mexico presents special risks that may affectour results******of operations.***

 

Our Mexican operationsface risks substantially similar to those we face in our Wal-Mart stores,including dependence on the host store and limits on expansion.  We cannot assure you that our Mexicanoperations will be able to attain profitability.

 

Our Mexican operationsexpose us to all of the risks of investing and operating in foreign countriesgenerally, including:

 

•             differingregulatory, political and governmental environments,

 

•             currencyfluctuations,

 

•             highinflation,

 

•             pricecontrols,

 

•             restrictionson profit repatriation,

 

•             generallylower per capita income and spending levels,

 

•             importduties and value-added taxes, and

 

•             difficultiesof cross-cultural marketing.

 

***Our Articles of Incorporation, By-Laws, Indenture, and thecompany shareholder******rights agreement contain provisions that make it moredifficult to effect a****change incontrol of the company, which may adversely affect the price of our****common stock.***

 

Provisions of ourArticles of Incorporation and By-Laws could discourage tender offers or othertransactions that would result in shareholders receiving a premium over themarket price for our common stock.  Theseinclude provisions:

 

•             authorizingthe issuance of preferred stock without shareholder approval,

 

•             requiringa supermajority shareholder vote in various circumstances,

 

•             restrictingwho may call a special meeting of shareholders,

 

•             permittingour board of directors to consider constituencies in addition to theshareholders, and

 

•             requiringshareholders to comply with various procedures in connection with anyshareholder proposals or director nominations.

 

The Indenture governingour Senior Subordinated Notes provides that, upon a “Change of Control” (asdefined), the Company is obligated to offer to repurchase all outstanding notesat par.  A “Change of Control” is definedto include, among other things, the acquisition by a group of 50% or more ofour common stock, and the election of a majority of directors who were notapproved by a majority of the prior directors. If a “Change of Control” occurs,we cannot assure you that we will have sufficient funds to repurchase all ofthe notes tendered.  Our failure torepurchase tendered notes would be an event of default under our indenture.

 

Our shareholder rightsagreement provides us with a defensive mechanism that decreases the risk that ahostile acquirer will attempt to take control of us without negotiatingdirectly with our board of directors.  Itis meant to prevent an acquirer from gaining control of us by paying aninadequate price or by using coercive techniques.  The shareholder rights agreement maydiscourage acquirers from attempting to purchase us, which may adversely affectthe price of our common stock.

 

***Compliance with Section 404 of the Sarbanes-Oxley Act of2002 is likely to be costly.***

 

We are in the process ofdocumenting and testing our internal control procedures in order to satisfy therequirements of Section 404 of the Sarbanes-Oxley Act, which requires annualmanagement assessments of the effectiveness of our internal

 

40

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controls over financialreporting and a report by our independent auditors addressing theseassessments.  We have added two permanentstaff positions, which we expect to supplement with temporary and contractemployees, in our efforts to achieve timely compliance.  Our efforts to comply with this Act haveresulted in, and will continue to result in, added expense and a diversion ofmanagement time from strategic activities to compliance activities.

 

***Failure to achieve and maintain effective internal controlprocedures could have a material adverse effect on our business, operatingresults and stock price.***

 

Effective internalcontrol is necessary for us to produce reliable financial reports and isimportant to helping prevent financial fraud. If we cannot provide reliable financial reports or prevent fraud, ourbusiness and operating results could be harmed, investors could lose confidencein our reported financial information, and the trading price of our stock coulddrop significantly.

 

**Item 7A.  Quantitative and Qualitative Disclosuresabout Market Risk**

 

***Market Risk. ***Marketrisk is the potential change in an instrument’s value caused by, for example,fluctuations in interest and currency exchange rates.  Our primary market risk exposures areinterest rate risk and the risk of unfavorable movements in exchange ratesbetween the U.S. dollar and the Mexican peso. Monitoring and managing these risks is a continual process carried outby senior management, which reviews and approves our risk managementpolicies.  We manage market risk on thebasis of an ongoing assessment of trends in interest rates, foreign exchangerates, and economic developments, giving consideration to possible effects onboth total return and reported earnings. Our financial advisors, both internal and external, provide ongoingadvice regarding trends that affect management’s assessment.  Our operations are not considered to giverise to significant market risk.

 

***Interest Rate Risk. ***Weborrow under our credit facility at variable interest rates. We therefore incurthe risk of increased interest costs if interest rates rise.  At January 1, 2005, we had no outstandingborrowings under our credit facility. Our interest cost under our Senior Subordinated Notes, due March 2009,is fixed at 12%.

 

***Foreign Currency Risk*. **Our division in Mexico operates in afunctional currency other than the U.S. dollar. The net assets of this division are exposed to foreign currencytranslation gains and losses, which are included as a component of accumulatedother comprehensive loss in shareholders’ equity.  Such translation resulted in an unrealizedgain of approximately $11,000 in 2004 and unrealized losses of $141,000 in 2003and $247,000 in 2002.  Historically, wehave not attempted to hedge this equity risk.

 

**Item 8.  Financial Statements and Supplementary Data**

 

Our ConsolidatedFinancial Statements are included as a separate section of this Reportcommencing on page F-1.

 

**Item 9.  Disagreements on Accounting and FinancialDisclosure**

 

None.

 

**Item9A.  Controls and Procedures**

 

As of the end of theperiod covered by this report, we carried out an evaluation, under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures pursuant toExchange Act Rule 13a-15.  Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures are effective as of the date ofsuch evaluation.  Disclosure controls andprocedures are controls and procedures that are designed to ensure thatinformation required to be disclosed in Company reports filed or submittedunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in the Securities and Exchange Commission’s rulesand forms.

 

There were no changes inour internal control over financial reporting that occurred during our fourthfiscal quarter that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.  Since the evaluation date, there have notbeen any significant changes in our internal controls, or in other factors thatcould significantly affect these controls subsequent to the evaluation date.

 

41

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## **Item 9B.  OtherInformation**

## ** **

All matters required to bedisclosed on Form 8-K during our fiscal 2004 fourth quarter have beenpreviously disclosed on a Form 8-K filed with the Securities and ExchangeCommission.

 

42

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**PART III**

 

**Item 10.  Directors and Executive Officers of theRegistrant**

 

**Information Concerning Directors**

 

The following information is provided, as of March 25, 2005, regardingcurrent directors:

 
| **Name**        | ** ** | **Age** | ** ** | **Positions  with the Company** |
|-----------------|------------|---------|------------|---------------------------------|
|            |       |    |       |                            |
| Peter T. Socha  |       | 45      |       | Chairman of the Board           |
|            |       |    |       |                            |
| B. Robert Floum |       | 69      |       | Director                        |
|            |       |    |       |                            |
| James W. Krause |       | 60      |       | Director                        |
|            |       |    |       |                            |
| Marc B. Nelson  |       | 43      |       | Director                        |
|            |       |    |       |                            |
| Jeffrey A. Snow |       | 53      |       | Director                        |

 

Directors are electedannually to serve until the next succeeding annual meeting of shareholders anduntil their respective successors are elected.

 

Mr. Socha joined theCompany in October 1999 as Senior Vice President, Strategic Planning. He servedas Senior Vice President, Strategic Planning and Managed Care from February2000 through June 2001. He became a director in February 2000 and was electedas Chairman of the Board in May 2002. In March 2003, he became President andChief Executive Officer of James River Coal Company (NASDAQ: JRCC) , a firmengaged in the mining, processing, and sale of steam coal. At James River, Mr. Socha was also responsiblefor managing its  reorganization underChapter 11 of the federal bankruptcy code, which  was instituted shortly after he joined thatcompany.

 

Mr. Floum became adirector in June 2001. From March 2000 through January 2001, he was actingChief Operating Officer of Stage Stores. He served as Chief Operating Officerof Jumbo Sports, a sporting goods company, from February 1998 through July1999.  He is a member of the Board ofDirectors of Holiday Diver, Inc., a Florida company engaged in the retail saleof water sports equipment.

 

Mr. Krause joined theCompany in April 1994 as President and Chief Executive Officer and a director.He was named Chairman of the Board in June 1995 and retired as an executive ofthe Company at the beginning of January 2003.

 

Dr. Nelson is anoptometrist licensed in New Jersey and Pennsylvania. Since 1992, he has beenthe president and sole shareholder of Nelson Eye Associates, P.C., whichoperates ten optometric clinics in retail optical locations owned by theCompany. He became a director in May 2002.

 

Mr. Snow became adirector in June 2001. He was President of Hi Fi Buys, Inc. from April 1982through May 1997. He is currently Chairman of Snows and Associates, LLC, aconsulting firm, where he has served since 1997.  He was a certified public accountant for 25years.

 

The Company has notimplemented any changes to the procedures by which security holders mayrecommend nominees to the Board of Directors since the Company most recentlydescribed these procedures in the proxy statement sent to shareholders inconnection with the 2004 annual meeting of shareholders.

 

The Company has aseparately-designated standing audit committee established in accordance withthe Securities Exchange Act. Messrs. Snow, Floum and Socha are members of thiscommittee. The Board of Directors has previously determined that each of Mr.Snow and Mr. Socha is an audit committee financial expert within the meaning ofapplicable regulations of the Securities and Exchange Commission.  Each of these individuals is independentunder the listing standards of the American Stock Exchange.

 

 

**ExecutiveOfficers**

 

The following table setsforth, as of March 25, 2005, certain information regarding the executiveofficers of the Company:

 

43

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| **Name**               | ** ** | **Age** | ** ** | **Positions with the Company**                                     |
|------------------------|------------|---------|------------|--------------------------------------------------------------------|
|                   |       |    |       |                                                               |
| Reade Fahs             |       | 43      |       | President and Chief  Executive Officer                             |
|                   |       |    |       |                                                               |
| J. Bruce Steffey       |       | 58      |       | Executive Vice  President, Chief Operating Officer                 |
|                   |       |    |       |                                                               |
| Jeff Busbee            |       | 44      |       | Vice President, Human  Resources and Corporate  Compliance         |
|                   |       |    |       |                                                               |
| Paul A. Criscillis, Jr |       | 55      |       | Senior Vice President,  Chief Financial Officer                    |
|                   |       |    |       |                                                               |
| Mitchell Goodman       |       | 51      |       | Senior Vice President,  General Counsel and Secretary              |
|                   |       |    |       |                                                               |
| Paul Gross             |       | 40      |       | Senior Vice President,  Marketing and New Ventures                 |
|                   |       |    |       |                                                               |
| Timothy W. Ranney      |       | 52      |       | Vice President, Finance  and Treasurer                             |
|                   |       |    |       |                                                               |
| Robert E. Schnelle     |       | 55      |       | Vice President, Chief  Accounting Officer                          |
|                   |       |    |       |                                                               |
| Robert W. Stein        |       | 49      |       | Senior Vice President,  Professional and Managed Care  Development |
|                   |       |    |       |                                                               |
| Desmond F. Taylor      |       | 51      |       | Senior Vice President,  Merchandising                              |

 

Mr. Fahs joined theCompany in April 2002 as President and Chief Operating Officer. He was namedChief Executive Officer in January 2003. From October 1999 until joining theCompany, he served first as Chief Executive Officer, then as ExecutiveDirector, of First Tuesday, a growth stage company based in the United Kingdom.From 1997 until 1999, he served as a Managing Director of Vision Express, anoptical retail company also based in the United Kingdom.

 

Mr. Steffey joined theCompany in September 2002 as Senior Vice President, Retail Operations. FromMarch 1995 to January 2002 he was employed by Zale Corporation, a companyengaged in the retail sales of jewelry, where he served as Senior VicePresident, Store Operations. He was appointed Executive Vice President, ChiefOperating Officer in March 2004.

 

Mr. Busbee joined theCompany in November 1995 as Director, Human Resources, was appointed a VicePresident in February 2000 and assumed his current position in March 2003.

 

Mr. Criscillis joined theCompany in January 2004 as Senior Vice President, Chief Financial Officer andTreasurer. He served as Chief Financial Officer for Barry Real EstateCompanies, a real estate management firm, from December 2002 through July 2003. He had served as Vice President, ChiefFinancial Officer for Suburban Lodges of America, Inc., an extended stay hotelchain,  from August 1998 through May2002.

 

Mr. Goodman joined theCompany as General Counsel and Secretary in September 1992 and was named a VicePresident in November 1993 and Senior Vice President in May 1998.

 

Mr. Gross joined theCompany in August 2002 as Senior Vice President, Marketing, FramesMerchandising and New Ventures. He assumed his current position in March 2004.He had served as Vice President for PC on Call LLC, a computer technologysupport firm, from August 2000 until shortly before joining the Company. FromSeptember 1991 until August 2000 he was employed by LensCrafters as Director ofMarketing.

 

Mr. Ranney joined theCompany in September 1998, was named Vice President, Corporate Controller inOctober 1998, and was named Vice President, Finance and Managed Care Operationsin August 2003. He was appointed Vice President, Finance in May 2004. He wasappointed Treasurer in February 2005.

 

Mr. Schnelle joined theCompany in April 2004 and in May 2004 was named Vice President, ChiefAccounting Officer. Before joining the Company, he served from June 2003 asVice President of Finance and Accounting at Wesley Hospitality, LLC., a hotelmanagement firm. From 1999 to 2002 he served as Vice President, Treasurer andChief Accounting Officer, at Suburban Lodges of America, Inc. From May 2002 toMay 2003, he consulted for Intown Suites Management, Inc., which had acquiredSuburban Lodges of America in May 2002.

 

Mr. Stein joined theCompany as Director of Human Resources in May 1992. In January 1993, he wasappointed Vice President, Human Resources, and was appointed Senior VicePresident in 1999. He was named Senior Vice President, Professional and ManagedCare Development in August 2003.

 

44

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Mr. Taylor joined theCompany in March 2004 as Senior Vice President, Merchandising. From 2002 toMarch 2004, he served as Chief Executive Officer of the U.S. subsidiary ofOptoplast PLC, a company engaged in the manufacture and distribution ofeyeglass cases and accessories. From 2000 to 2002, he served as CommercialDirector, Dollond & Aitchison, a retail optical firm in the United Kingdom.He was previously Store Development Director of Vision Express, a retailoptical firm in the United Kingdom, where he was employed from 1993 to 1999.

 

All executive officers ofthe Company are elected annually by and serve at the discretion of the Board ofDirectors. Each of Messrs. Krause, Socha, Goodman, Ranney, and Stein wereexecutive officers of the Company as of the time the Company filed its petitionfor protection under Chapter 11 of the Bankruptcy Code.

 

SECTION16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

 

Section 16(a) of theExchange Act requires the Company’s directors, executive officers and holdersof more than ten percent (10%) of our common stock to file with the Securitiesand Exchange Commission initial reports of ownership and reports of changes inownership of Common Stock and other equity securities of the Company. TheCompany believes that, during 2004, its officers, directors and holders of morethan ten percent (10%) of Common Stock complied with all Section 16(a) filingrequirements, except that a Form 4 was filed one day late relating to onetransaction for Mr. Floum.  In makingthese statements, the Company has relied upon the written representations ofits directors and officers and upon copies of reports furnished to the Company.

 

**CODE OFETHICS**

 

We have in place a Codeof Business Conduct and Ethics that applies to our employees, directors andcertain contractors. We have also adopted a Code of Ethics that applies to ourChief Executive Officer, Chief Financial Officer, and our Chief AccountingOfficer. We will provide a copy of this Code of Ethics to any person withoutcharge, upon written request sent to: Investor Relations, National Vision,Inc., 296 Grayson Highway, Lawrenceville, Georgia 30045.

 

 

**Item 11****.  ExecutiveCompensation**

 

COMPENSATIONOF EXECUTIVE OFFICERS

 

The following tablediscloses compensation received from the Company by the Company’s ChiefExecutive Officer and the Company’s four most highly compensated officers otherthan the Chief Executive Officer (all such individuals, collectively, the“named executive officers”).

 

45

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Summary Compensation Table

 
| ** **                     | ** ** | ** **               | ** ** | ** **    | ** ** | ** **     | ** ** | ** **          | ** ** | **Long  Term Compensation** | ** ** | ** **     | ** ** |
|--------------------------------|------------|--------------------------|------------|---------------|------------|----------------|------------|---------------------|------------|-----------------------------|------------|----------------|------------|
| ** **                     | ** ** | ** **               | ** ** | ** **    | ** ** | ** **     | ** ** | ** **          | ** ** | **Awards**                  | ** ** | **Payouts**    | ** ** | ** ** | ** ** |
| ** **                     | ** ** | ** **               | ** ** | ** **    | ** ** | ** **     | ** ** | ** **          | ** ** | **Restricted**              | ** ** | **Securities** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **Annual  Compensation** | ** ** | **Stock**     | ** ** | **Underlying** | ** ** | ** **          | ** ** | ** **                  | ** ** |
| **Name and Principal**         | ** ** | **Fiscal**               | ** ** | ** **    | ** ** | ** **     | ** ** | **Other  Annual**   | ** ** | **Award(s)**                | ** ** | **Options/**   | ** ** | **LTIP** | ** ** | **All  Other** | ** ** |
| **Position**                   | ** ** | **Year**                 | ** ** | **Salary($)** | ** ** | **Bonus($)**   | ** ** | **Compensation($)** | ** ** | **($)**                     | ** ** | **SARs(#)**    | ** ** | **Payouts($)** | ** ** | **Compensation($)** | ** ** |
| Reade Fahs                     |       | 2004                     |       | 310,000       |       | 369,000        |       | —              |       | 46,000                      | (1)        | —         |       | 441,000 | (2) | — |   |
| President and Chief Executive  |       | 2003                     |       | 300,000       |       | 69,000         |       | 46,000              | (3)        | 22,300                      | (4)        | —         |       | 44,000 | (5) | — |   |
|  Officer                  |       | 2002                     |       | 198,000       |       | 103,000        |       | 54,000              | (6)        | 63,400                      | (7)        | 165,600        |       | 10,000 | (8) | — |   |
|                           |       |                     |       |          |       |           |       |                |       |                        |       |           |       |   |   |   |   |
| J. Bruce Steffey               |       | 2004                     |       | 245,000       |       | 251,000        |       | 221,000             | (9)        | 23,000                      | (10)       | 30,000         |       | — |   | — |   |
| Executive Vice President and   |       | 2003                     |       | 217,000       |       | 38,000         |       | 9,000               | (11)       | 11,000                      | (12)       | —         |       | — |   | — |   |
| Chief Operating Officer        |       | 2002                     |       | 40,000        |       | 32,000         |       | 31,000              | (6)        | —                      |       | 9,000          |       | — |   | — |   |
|                           |       |                     |       |          |       |           |       |                |       |                        |       |           |       |   |   |   |   |
| Mitchell Goodman               |       | 2004                     |       | 207,000       |       | 185,000        |       | —              |       | 23,000                      | (10)       | —         |       | 89,000 | (13) | — |   |
| Senior Vice President, General |       | 2003                     |       | 198,000       |       | 34,000         |       | —              |       | 11,000                      | (12)       | —         |       | 9,000 | (14) | — |   |
| Counsel and Secretary          |       | 2002                     |       | 190,000       |       | 37,000         |       | —              |       | —                      |       | —         |       | 10,000 | (8) | — |   |
|                           |       |                     |       |          |       |           |       |                |       |                        |       |           |       |   |   |   |   |
| Paul A. Criscillis,Jr.         |       | 2004                     |       | 205,000       |       | 181,000        |       | 89,000              | (15)       | 23,000                      | (10)       | 22,000         |       | — |   | — |   |
| Senior Vice President,         |       | 2003                     |       | —        |       | —         |       | —              |       | —                      |       | —         |       | — |   | — |   |
| Chief Financial Officer        |       | 2002                     |       | —        |       | —         |       | —              |       | —                      |       | —         |       | — |   | — |   |
|                           |       |                     |       |          |       |           |       |                |       |                        |       |           |       |   |   |   |   |
| Robert A. Stein                |       | 2004                     |       | 185,000       |       | 163,000        |       | —              |       | 23,000                      | (10)       | —         |       | 89,000 | (13) | — |   |
| Senior Vice President,         |       | 2003                     |       | 163,000       |       | 28,000         |       | —              |       | 11,000                      | (12)       | —         |       | 9,000 | (14) | — |   |
| Professional and               |       | 2002                     |       | 157,000       |       | 28,000         |       | —              |       | —                      |       | —         |       | 10,000 | (8) | — |   |
| Managed Care Development       |       |                     |       |          |       |           |       |                |       |                        |       |           |       |   |   |   |   |

 

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(1)               Mr.Fahs was granted 20,000 shares of restricted stock on June 29, 2004 in twogrants of 10,000 shares each. Under the first grant, all shares vest on thethird anniversary of the grant date. Under the second grant, all shares vest onthe fifth anniversary of the grant date and may vest on the third anniversaryof the grant date if the Company attains a defined financial goal.  Dividends are payable on the restricted stock.  As of the end of fiscal 2004, Mr. Fahs owned55,000 shares of restricted stock with a value of $410,000.

 

(2)               Representscash settlement of $298,000 and award of 20,000 shares for achievement ofCompany goals in 2002-2004 performance period under long-term incentive plan.Shares valued at $7.15, the closing price on March 17, 2005, and actual valuewill depend on closing price as of date shares actually issued.

 

(3)               Substantiallyall of amount represents reimbursement for the payment of taxes.

 

(4)               Mr.Fahs was granted 26,250 shares of restricted stock on July 11, 2003. The sharesvest in one-third increments on each anniversary of the date of grant.Dividends are payable on the restricted stock.

 

(5)               Representscash settlement of $36,000 and issuance of 3,630 shares for achievement ofCompany goals in 2002-2003 performance period under long-term incentive plan.

 

(6)               Reimbursementof relocation expenses.

 

46

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(7)               Mr.Fahs was granted 84,400 shares of restricted stock on April 11, 2002. Theshares vest in one-third increments on each anniversary of the date of grant.Dividends are payable on the restricted stock.

 

(8)               Representscash settlement of $10,000 and issuance of 1,000 shares for achievement ofCompany goals in first year under long-term incentive plan.

 

(9)               Representsdiscretionary award of $149,000 and award of 10,000 shares under Company’sstock option and incentive award plan for assisting in achievement of Companygoals in 2002-2004 performance period under long-term incentive plan.  Shares valued at $7.15, the closing price onMarch 17, 2005, and actual value will depend on closing price as of date sharesactually issued.

 

(10) Executive wasgranted 10,000 shares of restricted stock on June 29, 2004 in two grants of5,000 shares each. Under the first grant, all shares vest on the thirdanniversary of the grant date. Under the second grant, all shares vest on thefifth anniversary of the grant date and may vest on the third anniversary ofthe grant date if the Company attains a defined financial goal.  Dividends are payable on the restrictedstock.  As of the end of fiscal 2004,each Executive (with the exception of Mr. Criscillis) owned 18,750 shares ofrestricted stock with a value of $140,000. Mr. Criscillis owned 10,000 shares of restricted stock with a value of$75,000.

 

(11) Representsdiscretionary award of $7,000 and award of 726 shares under Company’s stockoption and incentive award plan for assisting in achievement of Company goalsin 2002-2003 performance period under long-term incentive plan.

 

(12) Executive wasgranted 13,125 shares of restricted stock on July 11, 2003. The shares vest inone-third increments on each anniversary of the date of grant. Dividends arepayable on the restricted stock.

 

(13) Represents cashsettlement of $60,000 and award of 4,000 shares for achievement of Companygoals in 2002-2004 performance period under long-term incentive plan.  Shares valued at $7.15, the closing price onMarch 17, 2005, and actual value will depend on closing price as of date sharesactually issued.

 

(14)         Representscash settlement of $7,000 and issuance of 726 shares for achievement of Companygoals in 2002-2003 performance period under long-term incentive plan.

 

(15)         Representsdiscretionary award of $60,000 and award of 4,000 shares under Company’s stockoption and incentive award plan for assisting in achievement of Company goalsin 2002-2004 performance period under long-term incentive plan.  Shares valued at $7.15, the closing price onMarch 17, 2005, and actual value will depend on closing price as of date sharesactually issued.

 

47

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OPTIONGRANTS IN LAST FISCAL YEAR

 

The following tableprovides information regarding grants of stock options to the named executiveofficers in fiscal 2004.

 

 
| ** **              | ** ** | **Individual Grants**                                       | ** ** | ** **                                                              | ** ** | ** **                           | ** ** |
|-------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **              | ** ** | ** **                                                  | ** ** | ** **                                                              | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Name**                | ** ** | **Number of  Securities  Underlying  Options  Granted (#)** | ** ** | **Percent  of Total  Options  Granted  to  Employees  in Fiscal  Year** | ** ** | **Exercise  of Base  Price  ($/Sh)** | ** ** | **Expiration  Date** | ** ** | **Potential Realizable  Value at Assumed  Annual Rates of  Stock Price  Appreciation for  Option’s Term** | ** ** |
| ** **              | ** ** | ** **                                                  | ** ** | ** **                                                              | ** ** | ** **                           | ** ** | ** ** | ** ** | **5% ($)** | ** ** | **10% ($)** | ** ** |
| Reade Fahs              |       | NONE                                                        |       |                                                                    |       |                                 |       |   |   |   |   |   |   |
| J. Bruce Steffey        |       | 30,000                                                      |       | 34                                                                      |       | $                                    | 1.77       |   | 5/3/14 |   | 33,000 |   | 85,000 |   |
| Mitchell Goodman        |       | NONE                                                        |       |                                                                    |       |                                 |       |   |   |   |   |   |   |
| Paul A. Criscillis, Jr. |       | 22,000                                                      |       | 25                                                                      |       | $                                    | 2.38       |   | 1/29/14 |   | 33,000 |   | 83,000 |   |
| Robert A. Stein         |       | NONE                                                        |       |                                                                    |       |                                 |       |   |   |   |   |   |   |
|                         |            |                                                             |            |                                                                         |            |                                      |            |  |  |  |  |  |  |  |  |

 

AGGREGATEDOPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES

 

The following tableprovides information regarding the number and value of options held by thenamed executive officers.

 
| **Name**                | ** ** | **Shares  Acquired  On  Exercise (#)** | ** ** | **Value  Realized  ($)** | ** ** | **No. of Securities Underlying  Unexercised Options at Fiscal  Year End** | ** ** | **Value of Unexercised In-the-  Money Options at Fiscal  Year End($)** | ** ** |
|-------------------------|------------|----------------------------------------|------------|--------------------------|------------|---------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **              | ** ** | ** **                             | ** ** | ** **               | ** ** | **Exercisable**                                                           | ** ** | **Unexercisable(1)**                                                   | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Reade Fahs              |       |                                   |       |                     |       | 165,600                                                                   |       | 0                                                                      |       | 1,234,000 |   | 0 |   |
| J. Bruce Steffey        |       |                                   |       |                     |       | 6,000                                                                     |       | 33,000                                                                 |       | 45,000 |   | 246,000 |   |
| Mitchell Goodman        |       | 2,250                                  |       | 16,000                   |       | 0                                                                         |       | 6,750                                                                  |       | 0 |   | 50,000 |   |
| Paul A. Criscillis, Jr. |       |                                   |       |                     |       | 0                                                                         |       | 22,000                                                                 |       | 0 |   | 164,000 |   |
| Robert A. Stein         |       | 2,250                                  |       | 17,000                   |       |                                                                      |       | 6,750                                                                  |       |   |   | 50,000 |   |

 

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(1)               Sharesrepresented were not exercisable as of January 1, 2005, and futureexercisability is subject to the executive’s remaining employed by the Companythrough the vesting period.

 

48

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LONG-TERM INCENTIVE PLANS- AWARDS IN LASTFISCAL YEAR

 

The following table provides information regarding the number of unitsawarded to the named executive officers in fiscal 2004 under a long-termincentive plan.

 

| **Name**                | ** ** | **Number of  Shares, Units  or Other  Rights (#)** | ** ** | **Performance or Other  Period Until Maturation or  Payout** | ** ** |
|-------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **              | ** ** | ** **                                         | ** ** | ** **                                                   | ** ** |
| Reade Fahs              |       | 73,239                                             |       | (1                                                           | )          |
| J. Bruce Steffey        |       | 58,782                                             |       | (1                                                           | )          |
| Mitchell Goodman        |       | 36,823                                             |       | (1                                                           | )          |
| Paul A. Criscillis, Jr. |       | 35,834                                             |       | (1                                                           | )          |
| Robert A. Stein         |       | 25,145                                             |       | (1                                                           | )          |

 

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(1) Each unit representsthe right to a payment equal to the appreciation in the stock price of theCompany, based on the average closing saleprice of the common stock of the Company during the 20 consecutive trading daysending on June 29, 2007, from the stock price of the Company on June 29,2004 ($2.30), the date of the award.  The right to payment can be accelerated if, in certain circumstances,the employment of the executive is terminated within the one-year periodfollowing a change in control (as defined).

 

**Compensationof Directors**

 

Non-employee directors ofthe Company receive an annual retainer of $60,000 and also receive medical anddental benefits. Non-employee directors are also eligible to participate in the2004 Equity Incentive Plan, which was approved by the shareholders at the 2004Annual Meeting of Shareholders. Each director received an option for 10,000shares as of the date of that meeting. All current directors are non-employee directors.

 

**Changein Control Arrangements**

 

There are agreementsbetween the Company and the named executive officers which provide severancebenefits in the event of termination of employment under certain circumstancesfollowing a change in control of the Company (as defined). The circumstancesare termination by the Company (other than because of death or disabilitycommencing prior to a threatened change in control (as defined), or for cause(as defined)), or by an officer as the result of a voluntary termination (asdefined). Following any such termination, in addition to compensation andbenefits already earned, the officer will be entitled to receive a lump sumseverance payment equal to up to three times the officer’s annual rate of basesalary.

 

Cause for termination bythe Company is the: (i) commission of any act that constitutes, on the part ofthe officer, (a) fraud, dishonesty, gross negligence, or willful misconduct and(b) that directly results in material injury to the Company, or (ii) officer’smaterial breach of the agreement, or (iii) officer’s conviction of a felony orcrime involving moral turpitude.

 

Circumstances that wouldentitle the officer to terminate as a result of voluntary termination followinga change in control include, among other things: (i) the assignment to theofficer of any duties inconsistent with the officer’s title and status ineffect prior to the change in control or threatened change in control; (ii) areduction by the Company of the officer’s base salary; (iii) the Company’srequiring the officer to be based anywhere other than the Company’s principalexecutive offices; (iv) the failure by the Company, without the officer’sconsent, to pay to the officer any portion of the officer’s then currentcompensation; (v) the failure by the Company to continue in effect any materialcompensation plan in which the officer participates immediately prior to thechange in control or threatened change in control; or (vi) the failure by theCompany to continue to provide the officer with benefits substantially similarto those enjoyed by the officer under any of the Company’s life insurance,medical, or other plans. The term of each agreement is for a rolling threeyears unless the Company gives notice that it does not wish to extend suchterm, in which case the term of the agreement would expire three years from thedate of the notice.

 

These agreements are alsoin place between the Company and the other executive officers who are not the namedexecutive officers.

 

49

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The Company hasimplemented a severance plan which, in the case of executive officers, providesfor severance payment for one year to the executive following termination ofthe executive because of (i) a significant, adverse change in the executive’semployment responsibilities; (ii) a reduction in the executive’s base salary;(iii) relocation of more than 50 miles from the Company’s office; or (iv) thefailure of the Company to pay current compensation. Payments under theseverance plan are to be netted against any payments under the change incontrol agreement.

 

**COMPENSATIONCOMMITTEE INTERLOCKS AND INSIDER PARTICIPATION**

 

Messrs. Floum, Snow, andNelson served as members of the Compensation Committee in 2004.  Mr. Socha replaced Mr. Nelson as a member ofthe Committee in September 2004.  Mr.Socha was an officer of the Company from February 2000 through June 2001.

 

 

**Item 12****.  SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters.**

 

EquityCompensation Plan Information

** **
| **Plan Category**                                           | ** ** | **Number of  Securities to be  Issued Upon  Exercise of  Outstanding  Options, Warrants  and Rights (a)** | ** ** | **Weighted-  Average Exercise  Price of  Outstanding  Options,Warrants  and Rights(b)** | ** ** | **Number of  Securities  Remaining  Available for  Future  Issuance Under  Equity  Compensation  Plan (Excluding  Securities  reflected in  Column (a))(c)** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity compensation plans approved by  security holders(1)  |       | 562,275                                                                                                   | (2)        | $                                                                                       | 0.99       |                                                                                                                                                         | 247,240    | (3) |
| Equity compensation plans not approved by  security holders |       | N/A                                                                                                       |       | N/A                                                                                     |       | N/A                                                                                                                                                          |       |
|                                                             |            |                                                                                                           |            |                                                                                         |            |                                                                                                                                                              |            |  |

----

(1)               Atotal of 1,200,000 shares, inclusive of options previously granted under theplans described in the next sentence, are reserved for issuance under theCompany’s 2004 Equity Incentive Plan (the “Current Plan”). The Current Plan,which was approved by the shareholders at the 2004 Annual Meeting ofShareholders, replaced each of the Company’s Restated Stock Option andIncentive Award Plan and the Company’s Restated Non-Employee Director StockOption Plan. All information in this table is as of January 1, 2005.

 

(2)               Thereare currently outstanding, options covering 398,325 shares of common stock foremployees and options covering 180,200 shares of common stock for directors.

 

(3)               SinceApril 2002, the Company has awarded 361,400 shares of restricted stock toemployees, including the named executive officers.  The Company has cancelled 48,750 of theserestricted shares in connection with the termination of employment of certainofficers.  The Company has also awarded23,709 shares of common stock in partial settlement of performance shares.

 

50

----

 

SecurityOwnership of Certain Beneficial Owners

 

The Company is not awareof any person who, on March 25, 2005, was the beneficial owner of five percent(5%) or more of outstanding shares of Common Stock, except as set forth below.

 
| ** **                                | ** ** | **Amount and Nature  of Beneficial  Ownership** | ** ** | **Percent  of  Class(a)** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|---------------------------|------------|
| Northeast Investors Trust(b)              |       | 394,591                                         |       | 7.2                       |       |
| American Express Financial Corporation(c) |       | 329,879                                         |       | 6.0                       |       |

----

(a) A total of 5,458,343shares of common stock deemed outstanding for purposes of this calculation,including anticipated issuance of a total of 67,664 performance shares as aresult of achievement of Company financial goals in the 2002-2004 performanceperiod under long-term incentive plan.

 

(b)              Thisinformation is derived solely from a Schedule 13G filed on February 8, 2005.The address of this shareholder is 50 Congress Street, Boston, Massachusetts02109.

 

(c)               Thisinformation is derived solely from a Schedule 13G filed on February 11, 2005.The address of this shareholder is 50606 AXP Financial Center, Minneapolis,Minnesota 55474.

 

SecurityOwnership of Board and Management

 

The following table setsforth information, as of March 25, 2005, concerning beneficial ownership by alldirectors, by each of the executive officers named in the Summary CompensationTable below, and by all directors and executive officers as a group.

 
| **Name and Address of Beneficial  Owner(1)**                       | ** ** | **Number of  Shares  Beneficially  Owned** | ** ** | **Percent of  Outstanding  Common  Stock(2)** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------|------------|
| Reade Fahs                                                         |       | 253,980                                    | (a)        | 4.5                                           |       |
| Jeffrey A. Snow                                                    |       | 68,750                                     | (b)        | 1.3                                           |       |
| B. Robert Floum                                                    |       | 23,550                                     | (c)        | *                                             |       |
| James W. Krause                                                    |       | 11,250                                     | (d)        | *                                             |       |
| Peter T. Socha                                                     |       | 18,750                                     | (e)        | *                                             |       |
| Marc B. Nelson                                                     |       | 4,200                                      | (f)        | *                                             |       |
| Paul A. Criscillis, Jr.                                            |       | 21,333                                     | (g)        | *                                             |       |
| Mitchell Goodman                                                   |       | 29,647                                     | (h)        | *                                             |       |
| J. Bruce Steffey                                                   |       | 44,750                                     | (i)        | *                                             |       |
| Robert A. Stein                                                    |       | 29,951                                     | (h)        | *                                             |       |
| All directors and executive officers as a group  (fifteen persons) |       | 588,360                                    |       | 10.2                                          |       |

----

 *  Represents less than one percent of the outstanding Common Stock.

 

(1)               Theaddress of the persons named is 296 Grayson Highway, Lawrenceville, GA 30045.

 

(2) A total of 5,739,309shares of common stock deemed outstanding for purposes of this calculation,including anticipated issuance of a total of 67,664 performance shares as aresult of achievement of Company financial goals in the 2002-2004 performanceperiod under long-term incentive plan.

 

(a)               Includes165,600 shares that Mr. Fahs has the right to acquire pursuant to a stockoption granted by the Company.  Alsoincludes 20,000 performance shares to be awarded for achievement of Companyfinancial goals during 2002-2004 performance period.

 

(b)              Includes2,500 shares that Mr. Snow has the right to acquire pursuant to a stock optiongranted by the Company.

 

(c)               Includes18,250 shares that Mr. Floum has the right to acquire pursuant to stock optionsgranted by the Company.

 

51

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(d)              Represents11,250 shares that Mr. Krause has the right to acquire from the Company.

 

(e)               Represents18,750 shares that Mr. Socha has the right to acquire pursuant to stock optionsgranted by the Company.

 

(f)                 Includes2,700 shares that Dr. Nelson has the right to acquire pursuant to a stockoption granted by the Company.

 

(g)              Includes7,333 shares that Mr. Criscillis has the right to acquire pursuant to a stockoption granted by the Company.  Alsoincludes 4,000 performance shares to be awarded for assistance in achievementof Company financial goals during 2002-2004 performance period.

 

(h)              Includes6,750 shares that this executive has the right to acquire pursuant to a stockoption granted by the Company.  Alsoincludes 4,000 performance shares to be awarded for achievement of Companyfinancial goals during 2002-2004 performance period.

 

(i)                  Includes16,000 shares that Mr. Steffey has the right to acquire pursuant to a stockoption granted by the Company.  Alsoincludes 10,000 performance shares to be awarded for assistance in achievementof Company financial goals during 2002-2004 performance period.

 

 

**Item 13****. Certain Relationships and Related Transactions**

 

 

In 2004, Nelson EyeAssociates, P.C., which is wholly owned by Marc B. Nelson, a director of theCompany, paid the Company approximately $300,000 in occupancy fees related tothe sub-occupancy of ten retail optical locations operated by the Company.  In addition, the Company incurred expense ofapproximately $7,000 pursuant to a consulting agreement with Dr. Nelson forservices with respect to our freestanding vision centers.  The Audit Committee of the Board of Directorsapproved this arrangement.

 

 

**Item 14****. Principal Accountant Fees and Services.**

 

**Fees ofIndependent Accountants**

 

*AuditFees.*  The aggregatefees billed for each of the last two fiscal years for professional servicesrendered by the Company’s principal accounting firm, Deloitte & Touche LLP(the “Accounting Firm”) for the audit of the Company’s annual financialstatements and the review of the financial statements included in the Company’sForms 10-Q or services that are normally provided by the accountant inconnection with statutory and regulatory filings or engagements for thosefiscal years were as follows:

 
| **Fiscal 2004** | ** ** | **Fiscal  2003** | ** ** |
|-----------------|------------|------------------|------------|
| $               | 407,000    |             | $          | 459,000* |   |
|                 |            |                  |            |  |  |

----

* Includes fees billedfor the restatement of the Company’s financial statements for fiscal 2001.

 

52

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*Audit-RelatedFees.*  The aggregatefees billed in each of the last two fiscal years for assurance and relatedservices by the Accounting Firm that were reasonably related to the performanceof the audit and reviews of our financial statements and are not reported abovewere as follows:

 
| **Fiscal 2004** | ** ** | **Fiscal 2003** | ** ** |
|----------------------|------------|----------------------|------------|
| $                    | 3,000      |                 | $          | 105,000 |   |
|                      |            |                      |            |  |  |

 

These services were foraccounting consultation.

 

*TaxFees.*  The aggregatefees billed in each of the last two fiscal years for professional servicesrendered by the Accounting Firm for tax compliance, tax advice, and taxplanning were as follows:

 
| **Fiscal 2004** | ** ** | **Fiscal 2003** | ** ** |
|-----------------|------------|-----------------|------------|
| $               | 112,000    |            | $          | 113,000 |   |
|                 |            |                 |            |  |  |

 

*AllOther Fees.*  TheAccounting Firm did not bill us in fiscal 2003 for any other products andservices.  The Accounting Firm billed us$8,000 in 2004 for consultation in connection with our efforts to comply withthe internal control requirements under Section 404 of the Sarbanes-Oxley Act.

 

Under the Exchange Act,the Audit Committee must, either directly or through established pre-approvalpolicies, pre-approve all services rendered by the Accounting Firm. The ExchangeAct also provides that the Audit Committee can, in the case of certain servicesthat do not represent in excess of five percent of the fees we pay to theAccounting Firm, approve the services after they have been rendered. The AuditCommittee did not use this exception to approve any of the services performedby the Accounting Firm. The Audit Committee currently has no pre-approvalpolicies and procedures other than that the Committee itself pre-approves allservices provided by the Accounting Firm.

 

53

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**PART IV**

 

**Item 15.  Exhibits and Financial Statement Schedules**

 

(1) and (2) The Company’sConsolidated Financial Statements and Schedule are filed as a separate sectionof this Report commencing on page F-1.

 

(3) Wehave filed or furnished the following exhibits:

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 2.1 -               |       | First Amended Joint  Plan of Reorganization Under Chapter 11, Title 11, United States Code, filed  by Vista Eyecare, Inc. and certain of its Debtor Subsidiaries, dated April  13, 2001, incorporated by reference to Exhibit 2.1 to our Current Report on  Form 8-K filed with the Commission on June 1, 2001.                                                                                                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 2.2 -               |       | Modification to First Amended Joint Plan of  Reorganization Under Chapter 11, Title 11, United States Code, filed by Vista  Eyecare, Inc. and certain of its Debtor Subsidiaries and First Amended Joint  Plan of Reorganization Under Chapter 11, Title 11, United States Code, filed  by Frame-n-Lens Optical, Inc.; Midwest Vision, Inc.; New West Eyeworks, Inc.,  and certain of their Debtor Subsidiaries, dated May 17, 2001, incorporated by  reference to Exhibit 2.2 to our Current Report on Form 8-K filed with the  Commission on June 1, 2001. |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 3.1 -               |       | Amended and Restated  Articles of Incorporation of the Company dated April 8, 1992, as amended,  incorporated by reference to Exhibit 3.1 to our Registration Statement on  Form 8-A filed with the Commission on August 9, 2001.                                                                                                                                                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 3.2 -               |       | Amended and Restated  By-Laws of the Company, incorporated by reference to our Registration Statement  on Form S-1, registration number 33-46645, filed with the Commission on March  25, 1992, and amendments thereto.                                                                                                                                                                                                                                                                                                                                      |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.1 -               |       | Form of Common Stock  Certificate, incorporated by reference to Exhibit 4.1 to our Registration  Statement on Form 8-A filed with the Commission on August 9, 2001.                                                                                                                                                                                                                                                                                                                                                                                          |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.2 -               |       | Rights Agreement dated  as of January 17, 1997, between the Company and Wachovia Bank of North  Carolina, N.A., incorporated by reference to our Registration Statement on  Form 8-A filed with the Commission on January 17, 1997.                                                                                                                                                                                                                                                                                                                          |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.3 -               |       | Amendment to Rights  Agreement, dated as of March 1, 1998, between the Company and Wachovia Bank  of North Carolina, N.A., incorporated by reference to Exhibit 10.2 to our  Registration Statement on Form 8-A filed with the Commission on March 24,  1998.                                                                                                                                                                                                                                                                                                |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.4 -               |       | Second Amendment to  Rights Agreement, dated as of June 1, 1999, between the Company and First  Union National Bank, as successor to Wachovia Bank, N.A., incorporated by  reference to our Annual Report on Form 10-K for the fiscal year ended January  3, 2004.                                                                                                                                                                                                                                                                                           |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.5 -               |       | Indenture dated as of  June 15, 2001, between the Company and State Street Bank and Trust Company,  as trustee, incorporated by reference to Exhibit 4.4 to our Annual Report on  Form 10-K for the fiscal year ended December 28, 2002.                                                                                                                                                                                                                                                                                                                     |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.6 -               |       | First Amendment of  Indenture, dated as of July 6, 2001, between the Company and State Street  Bank and Trust Company, as trustee, incorporated by reference to Exhibit 4.2  to our Registration Statement on Form 8-A filed with the Commission on August  9, 2001.                                                                                                                                                                                                                                                                                         |

 

54

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| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                 |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.7 -               |       | Lock-Up Agreement dated  May 31, 2001, between Scudder High Yield Series - Scudder High Yield Fund and  the Company, incorporated by reference to Exhibit 4.8 to our Annual Report on  Form 10-K for the fiscal year ended December 29, 2001.                                                                                                                                                                                   |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.8 -               |       | Lock-Up Agreement dated  May 31, 2001, between U.S. Bancorp Investments, Inc. and the Company,  incorporated by reference to Exhibit 4.9 to our Annual Report on Form 10-K  for the fiscal year ended December 29, 2001.                                                                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.9 -               |       | Second Amendment of  Indenture, dated as of December 7, 2001, between the Company and State Street  Bank and Trust Company, as trustee, incorporated by reference to Exhibit 4.10  to our Annual Report on Form 10-K for the fiscal year ended December 29,  2001.                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.10 -              |       | Agreement of  Substitution and Third Amendment to Rights Agreement, dated as of March 5,  2004, by and between National Vision, Inc. and American Stock Transfer &  Trust Company, a New York banking corporation, incorporated by reference to  our Current Report on Form 8-K filed with the Commission on March 23, 2004.                                                                                                |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.1 -              |       | Vision Center Master  License Agreement dated as of June 16, 1994, by and between Wal-Mart Stores,  Inc. and the Company, incorporated by reference to our Quarterly Report on  Form 10-Q for the quarterly period ended September 30, 1994.                                                                                                                                                                                    |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.2 -              |       | Sublease Agreement  dated December 16, 1991, by and between Wal-Mart Stores, Inc. and the Company,  incorporated by reference to our Registration Statement on Form S-1,  registration number 33-46645, filed with the Commission on March 25, 1992,  and amendments thereto.                                                                                                                                                   |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.3 -              |       | Retail Lease Agreement  dated March 1999 between Fred Meyer Stores, Inc. and the Company,  incorporated by reference to our Annual Report on Form 10-K for the fiscal  year ended January 3, 2004. [Portions of Exhibit 10.4 have been omitted  pursuant to an order for confidential treatment issued by the Commission. The  omitted portions have been filed separately with the Commission.]                                |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.4 -              |       | Lease Extension and  Modification Agreement, dated as of July 1, 2003, between Fred Meyer Stores,  Inc. and the Company, incorporated by reference to our Annual Report on Form  10-K for the fiscal year ended January 3, 2004. [Portions of Exhibit 10.5  have been omitted pursuant to an order for confidential treatment issued by  the Commission. The omitted portions have been filed separately with the  Commission.] |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.5 -              |       | Restated Stock Option  and Incentive Award Plan, incorporated by reference to our Annual Report on  Form 10-K for the fiscal year ended January 3, 2004. ++                                                                                                                                                                                                                                                                     |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.6 –         |       | Restated Non-Employee Director Stock Option Plan,  incorporated by reference to our Quarterly Report on Form 10-Q for the  quarterly period ended June 28, 1997.++                                                                                                                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.7 -              |       | Form Restricted Stock  Award, incorporated by reference to our Quarterly Report on Form 10-Q for the  quarterly period ended March 29, 1997.++                                                                                                                                                                                                                                                                                  |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.8 -              |       | Restricted Stock Award  made as of April 11, 2002, by the Company to L. Reade Fahs, incorporated by  reference to our Quarterly Report on Form 10-Q for the quarterly period ended  June 29, 2002.++                                                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.9 -              |       | Form Performance Share  Award Agreement, incorporated by reference to our Quarterly Report on Form  10-Q for the quarterly period ended June 29, 2002.++                                                                                                                                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.10 -             |       | Form Stock Option 2001  Grant for Employees, incorporated by reference to our Quarterly Report on  Form 10-Q for the quarterly period ended June 29, 2002.++                                                                                                                                                                                                                                                                    |

 

55

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| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                            |
|---------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                                       |
| 10.11 -             |       | Form Change in Control  Agreement, incorporated by reference to our Annual Report on Form 10-K for  the fiscal year ended December 30, 2000.++                                                                                                             |
|                |       |                                                                                                                                                                                                                                                       |
| 10.12 -             |       | Form indemnification agreement for directors and  executive officers of the Company, incorporated by reference to our Quarterly  Report on Form 10-Q for the quarterly period ended June 30, 2001.                                                         |
|                |       |                                                                                                                                                                                                                                                       |
| 10.13 -             |       | Split Dollar Life  Insurance Agreement dated as of November 3, 1994, among the Company, A.  Kimbrough Davis, as Trustee, and James W. Krause, incorporated by reference  to our Annual Report on Form 10-K for the fiscal year ended December 31,  1994.++ |
|                |       |                                                                                                                                                                                                                                                       |
| 10.14 -             |       | Management Incentive Plan, incorporated by reference  to our Annual Report on Form 10-K for the fiscal year ended January 3, 2004.  ++                                                                                                                     |
|                |       |                                                                                                                                                                                                                                                       |
| 10.15 -             |       | Executive Relocation  Policy, incorporated by reference to our Quarterly Report on Form 10-Q for  the quarterly period ended March 30, 1996.++                                                                                                             |
|                |       |                                                                                                                                                                                                                                                       |
| 10.16 -             |       | Loan and Security  Agreement dated as of May 30, 2001, between the Company and Fleet Capital  Corporation, incorporated by reference to our Quarterly Report on Form 10-Q  for the quarterly period ended June 30, 2001.                                   |
|                |       |                                                                                                                                                                                                                                                       |
| 10.17 -             |       | First Amendment to Loan  and Security Agreement, dated as of December 21, 2001, between the Company  and Fleet Capital Corporation, incorporated by reference to our Annual Report  on Form 10-K for the fiscal year ended January 3, 2004.                |
|                |       |                                                                                                                                                                                                                                                       |
| 10.18 -             |       | Letter Agreement, dated  June 30, 2002, between the Company and Fleet Capital Corporation incorporated  by reference to our Quarterly Report on Form 10-Q for the quarterly period  ended September 28, 2002.                                              |
|                |       |                                                                                                                                                                                                                                                       |
| 10.19 -             |       | Second Amendment to  Loan and Security Agreement, dated as of December 19, 2003, between the  Company and Fleet Capital Corporation, incorporated by reference to our  Annual Report on Form 10-K for the fiscal year ended January 3, 2004.               |
|                |       |                                                                                                                                                                                                                                                       |
| 10.20               |       | Fourth Amendment to Loan and Security Agreement,  dated as of April 1, 2004, between the Company and Fleet Capital Corporation,  incorporated by reference to our Quarterly Report on Form 10-Q for the  quarterly period ended April 3, 2004.             |
|                |       |                                                                                                                                                                                                                                                       |
| 10.21               |       | 2004 Equity Incentive Plan, incorporated by  reference to our definitive proxy statement filed with the Commission on May  3, 2004.++                                                                                                                      |
|                |       |                                                                                                                                                                                                                                                       |
| 10.22               |       | Letter Agreement dated as of August 20, 2004 between  the Company and Marc B. Nelson, incorporated by reference to our Quarterly  Report on Form 10-Q for the quarterly period ended October 2, 2004.++                                                    |
|                |       |                                                                                                                                                                                                                                                       |
| 10.23               |       | Letter Agreement, dated as of August 19, 2004,  between the Company and Fleet Retail Group, Inc. *                                                                                                                                                         |
|                |       |                                                                                                                                                                                                                                                       |
| 10.24               |       | Sixth Amendment to Loan and Security Agreement,  dated as of October 26, 2004, between the Company and Fleet Retail Group,  Inc., incorporated by reference to our Current Report on Form 8-K filed with  the Commission on October 29, 2004.              |
|                |       |                                                                                                                                                                                                                                                       |
| 10.25               |       | Letter Agreement, dated March 21, 2005, between the  Company and Fleet Capital Corporation, incorporated by reference to our  Current Report on Form 8-K filed with the Commission on March 22, 2005.                                                      |
|                |       |                                                                                                                                                                                                                                                       |
| 10.26               |       | Form Performance Unit Award ++*                                                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                       |
| 21 -                |       | Subsidiaries of the  Registrant.*                                                                                                                                                                                                                          |
|                |       |                                                                                                                                                                                                                                                       |
| 23.1 -              |       | Consent of Deloitte  & Touche LLP.*                                                                                                                                                                                                                    |
|                |       |                                                                                                                                                                                                                                                       |
| 31.1 -              |       | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*                                                                                                                                                      |

 

56

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| 31.2 - |   | Certification of Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.* |
|--------|--------|-------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                  |
| 32.1 - |   | Certification of Chief  Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* |
|   |   |                                                                                                  |
| 32.2 - |   | Certification of Chief  Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* |

 

----

*  Filed with this Form 10-K.

 

++ Management contract orcompensatory plan or arrangement in which a director or named executive officerparticipates.

 

57

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**NationalVision, Inc. and Subsidiaries**

 

**ConsolidatedFinancial Statements and Schedule**

**Forthe years ended January 1, 2005, January 3, 2004 and December 28,2002**

 

**INDEX TOCONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE**

 

Thefollowing consolidated financial statements and schedule of the registrantand its subsidiaries are submitted herewith in response to Item 8 and Item 14(a)1 and to Item 14(a)2, respectively.

 
| Report  of Independent Registered Public Accounting Firm                                                                                                                                                                                                                                                              |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                                                                                                                                                                                  |   |
| Consolidated Balance Sheets  as of January 1, 2005 and January 3, 2004                                                                                                                                                                                                                                      |   |
|                                                                                                                                                                                                                                                                                                                  |   |
| Consolidated  Statements of Operations for the Years Ended January 1, 2005, January 3,  2004 and December 28, 2002                                                                                                                                                                                     |   |
|                                                                                                                                                                                                                                                                                                                  |   |
| Consolidated  Statements of Shareholders’ Equity for the Years Ended January 1, 2005, January 3,  2004 and December 28, 2002                                                                                                                                                                      |   |
|                                                                                                                                                                                                                                                                                                                  |   |
| Consolidated  Statements of Cash Flows for the Years Ended January 1, 2005, January 3,  2004 and December 28, 2002                                                                                                                                                                                     |   |
|                                                                                                                                                                                                                                                                                                                  |   |
| Notes to  Consolidated Financial Statements                                                                                                                                                                                                                                                                           |   |
|                                                                                                                                                                                                                                                                                                                  |   |
| Separate  financial statements of the registrant have been omitted because it is  primarily an operating company and all of its subsidiaries are included in  the consolidated financial statements.                                                                                                                  |   |
|                                                                                                                                                                                                                                                                                                                  |   |
| Schedule II -  Valuation and Qualifying Accounts                                                                                                                                                                                                                                                                 |   |
|                                                                                                                                                                                                                                                                                                                  |   |
| All other  schedules for which provision is made in the applicable accounting  regulations of the Securities and Exchange Commission are not required under  the related instructions, are inapplicable, or have been disclosed in the  notes to consolidated financial statements and, therefore, have been omitted. |   |

 

F-1

----

 

REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Directors and Shareholders

National Vision, Inc.

Lawrenceville, Georgia

 

We have auditedthe accompanying consolidated balance sheets of National Vision, Inc. andsubsidiaries (the “Company”) as of January 1, 2005 and January 3,2004, and the related consolidated statements of operations, shareholders’equity, and cash flows for each of the three years in the period ended January 1,2005.  Our audits also included thefinancial statement schedule listed in the Index at page F-1.  These consolidated financial statements andthe financial statement schedule are theresponsibility of the Company’s management. Our responsibility is to express an opinion on the consolidatedfinancial statements and financial statement schedule based on our audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States).  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, anaudit of its internal control over financial reporting.** **Anaudit includes consideration of internal control over financial reporting as abasis for designing audit procedures that are appropriate in the circumstances,but not for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly,in all material respects, the financial position of National Vision, Inc. andsubsidiaries as of January 1, 2005 and January 3, 2004, and theresults of their operations and their cash flows for each of the three years inthe period ended January 1, 2005, in conformity with accounting principlesgenerally accepted in the United States of America.  Also, in our opinion, the financial statementschedule listed in the Index at page F-1, when considered in relation to thebasic consolidated financial statements taken as a whole, presents fairly inall material respects the information set forth therein.

 

DELOITTE & TOUCHE  LLP

 

Atlanta, Georgia

March 24,2005

 

F-2

----

 

**NationalVision, Inc.**

**ConsolidatedBalance Sheets**

**January 1, 2005 and January 3,2004**

**(in thousands, except shareinformation)**

** **
| ** **                                                                                                                                                                                                                                                     | ** ** | **January 1,  2005** | ** ** | **January 3,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| **ASSETS**                                                                                                                                                                                                                                                     |       |                      |       |                      |       |
|                                                                                                                                                                                                                                                           |       |                      |       |                      |       |
| **CURRENT ASSETS:**                                                                                                                                                                                                                                            |       |                      |       |                      |       |
| Cash  and cash equivalents                                                                                                                                                                                                                                     |       | $                         | 7,858      |                      | $          | 3,545 |   |
| Accounts  receivable (net of allowances: 2004 - $423; 2003 - $769)                                                                                                                                                                                             |       | 2,561                     |       | 3,078                     |       |
| Inventories                                                                                                                                                                                                                                                    |       | 14,065                    |       | 17,387                    |       |
| Deferred  income tax asset                                                                                                                                                                                                                                     |       | 9,394                     |       | 7,305                     |       |
| Other  current assets                                                                                                                                                                                                                                          |       | 2,405                     |       | 1,278                     |       |
| Total  current assets                                                                                                                                                                                                                                          |       | 36,283                    |       | 32,593                    |       |
|                                                                                                                                                                                                                                                           |       |                      |       |                      |       |
| **PROPERTY AND EQUIPMENT:**                                                                                                                                                                                                                                    |       |                      |       |                      |       |
| Equipment                                                                                                                                                                                                                                                      |       | 22,250                    |       | 20,383                    |       |
| Furniture  and fixtures                                                                                                                                                                                                                                        |       | 7,648                     |       | 7,785                     |       |
| Leasehold  improvements                                                                                                                                                                                                                                        |       | 6,513                     |       | 6,556                     |       |
| Construction  in progress                                                                                                                                                                                                                                      |       | 1,496                     |       | 1,750                     |       |
|                                                                                                                                                                                                                                                           |       | 37,907                    |       | 36,474                    |       |
| Less  accumulated depreciation                                                                                                                                                                                                                                 |       | (25,636                   | )          | (22,855                   | )          |
| Net  property and equipment                                                                                                                                                                                                                                    |       | 12,271                    |       | 13,619                    |       |
|                                                                                                                                                                                                                                                           |       |                      |       |                      |       |
| **OTHER ASSETS AND DEFERRED COSTS**                                                                                                                                                                                                                            |       |                      |       |                      |       |
| (net  of accumulated amortization: 2004 - $1,193; 2003 - $964)                                                                                                                                                                                                 |       | 785                       |       | 806                       |       |
|                                                                                                                                                                                                                                                           |       |                      |       |                      |       |
| **INTANGIBLE VALUE OF CONTRACTUAL RIGHTS**                                                                                                                                                                                                                     |       |                      |       |                      |       |
| (net  of accumulated amortization: 2004 - $26,974; 2003 - $19,466)                                                                                                                                                                                             |       | 85,771                    |       | 93,279                    |       |
|                                                                                                                                                                                                                                                           |       | $                         | 135,110    |                      | $          | 140,297 |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                                                                  |       |                      |       |                      |       |
|                                                                                                                                                                                                                                                           |       |                      |       |                      |       |
| **CURRENT LIABILITIES:**                                                                                                                                                                                                                                       |       |                      |       |                      |       |
| Accounts  payable                                                                                                                                                                                                                                              |       | $                         | 3,446      |                      | $          | 3,506 |   |
| Accrued  expenses and other current liabilities                                                                                                                                                                                                                |       | 23,772                    |       | 25,132                    |       |
| Current  portion of long-term debt                                                                                                                                                                                                                             |       | 4,858                     |       | 545                       |       |
| Total  current liabilities                                                                                                                                                                                                                                     |       | 32,076                    |       | 29,183                    |       |
|                                                                                                                                                                                                                                                           |       |                      |       |                      |       |
| **DEFERRED INCOME TAX LIABILITY**                                                                                                                                                                                                                              |       | 8,191                     |       | 7,305                     |       |
|                                                                                                                                                                                                                                                           |       |                      |       |                      |       |
| **SENIOR SUBORDINATED NOTES**                                                                                                                                                                                                                                  |       | 72,930                    |       | 94,939                    |       |
|                                                                                                                                                                                                                                                           |       |                      |       |                      |       |
| **OTHER NON-CURRENT LIABILITIES**                                                                                                                                                                                                                              |       | 491                       |       |                      |       |
|                                                                                                                                                                                                                                                           |       |                      |       |                      |       |
| **COMMITMENTS AND CONTINGENCIES**                                                                                                                                                                                                                              |       |                      |       |                      |       |
|                                                                                                                                                                                                                                                           |       |                      |       |                      |       |
| **SHAREHOLDERS’ EQUITY:**                                                                                                                                                                                                                                 |       |                      |       |                      |       |
| Preferred  stock, $1 par value; 5,000,000 shares authorized; none issued

Common  stock, $0.01 par value; 10,000,000 shares authorized, 5,390,679 and 5,243,047  shares issued and outstanding at January 1, 2005 and January 3,  2004, respectively |       | 54                        |       | 52                        |       |
| Additional  paid-in capital                                                                                                                                                                                                                                    |       | 25,592                    |       | 25,129                    |       |
| Deferred  stock compensation                                                                                                                                                                                                                                   |       | (407                      | )          | (108                      | )          |
| Accumulated  deficit                                                                                                                                                                                                                                           |       | (3,557                    | )          | (15,932                   | )          |
| Accumulated  other comprehensive loss                                                                                                                                                                                                                          |       | (260                      | )          | (271                      | )          |
| Total  shareholders’ equity                                                                                                                                                                                                                               |       | 21,422                    |       | 8,870                     |       |
|                                                                                                                                                                                                                                                           |       | $                         | 135,110    |                      | $          | 140,297 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

F-3

----

 

**NationalVision, Inc.**

**ConsolidatedStatements of Operations**

**Forthe years ended January 1, 2005 (Fiscal 2004),**

**January 3,2004 (Fiscal 2003) and December 28, 2002 (Fiscal 2002)**

(in thousands, except per share information)

 
| ** **                                                                                                        | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                                                              |       |     |       |     |       |     |       |
| Sales of optical  products and services                                                                           |       | $        | 220,759    |     | $          | 210,368  |       | $ | 196,123 |   |
| Fees from managed  vision care services                                                                           |       | 7,835    |       | 6,346    |       | 1,699    |       |
| Sales of home medical  products and services                                                                      |       | 258      |       |     |       |     |       |
| Total net revenue                                                                                                 |       | 228,852  |       | 216,714  |       | 197,822  |       |
| Cost of goods sold,  including occupancy costs                                                                    |       | 101,167  |       | 97,532   |       | 87,538   |       |
| Gross profit                                                                                                      |       | 127,685  |       | 119,182  |       | 110,284  |       |
| Selling, general and  administrative expense                                                                      |       | 111,119  |       | 113,804  |       | 108,989  |       |
| Operating income from  continuing operations                                                                      |       | 16,566   |       | 5,378    |       | 1,295    |       |
| Other income (expense):                                                                                           |       |     |       |     |       |     |       |
| Interest expense                                                                                                  |       | (10,595  | )          | (12,913  | )          | (14,099  | )          |
| Gain on repurchase of  Notes                                                                                      |       | 3,166    |       | 2,321    |       | 1,566    |       |
| Other income, net                                                                                                 |       | 164      |       | 50       |       | 470      |       |
| Earnings (loss) before  taxes, discontinued operations and cumulative effect of a change in  accounting principle |       | 9,301    |       | (5,164   | )          | (10,768  | )          |
| Income tax expense (benefit)                                                                                      |       | (822     | )          | 136      |       |     |       |
| Net earnings (loss)  before discontinued operations and cumulative effect of a change in  accounting principle    |       | 10,123   |       | (5,300   | )          | (10,768  | )          |
| Income from  discontinued operations, net of taxes                                                                |       | 2,252    |       | 1,996    |       | 4,564    |       |
| Earnings (loss) before  cumulative effect of a change in accounting principle                                     |       | 12,375   |       | (3,304   | )          | (6,204   | )          |
| Cumulative effect of a  change in accounting principle                                                            |       |     |       | (564     | )          |     |       |
| Net earnings (loss)                                                                                               |       | $        | 12,375     |     | $          | (3,868   | )          | $ | (6,204 | ) |
|                                                                                                              |       |     |       |     |       |     |       |
| Basic earnings (loss)  per share:                                                                                 |       |     |       |     |       |     |       |
| Income (loss) from  continuing operations                                                                         |       | $        | 1.99       |     | $          | (1.05    | )          | $ | (2.15 | ) |
| Income from  discontinued operations                                                                              |       | 0.44     |       | 0.39     |       | 0.91     |       |
| Earnings (loss) before  cumulative effect                                                                         |       | 2.43     |       | (0.66    | )          | (1.24    | )          |
| Cumulative effect, net                                                                                            |       |     |       | (0.11    | )          |     |       |
| Net earnings (loss) per  basic share                                                                              |       | $        | 2.43       |     | $          | (0.77    | )          | $ | (1.24 | ) |
|                                                                                                              |       |     |       |     |       |     |       |
| Diluted earnings (loss)  per share:                                                                               |       |     |       |     |       |     |       |
| Income (loss) from  continuing operations                                                                         |       | $        | 1.81       |     | $          | (1.05    | )          | $ | (2.15 | ) |
| Income from  discontinued operations                                                                              |       | 0.40     |       | 0.39     |       | 0.91     |       |
| Earnings (loss) before  cumulative effect                                                                         |       | 2.21     |       | (0.66    | )          | (1.24    | )          |
| Cumulative effect, net                                                                                            |       |     |       | (0.11    | )          |     |       |
| Net earnings (loss) per  diluted share                                                                            |       | $        | 2.21       |     | $          | (0.77    | )          | $ | (1.24 | ) |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

F-4

----

 

**NationalVision, Inc.**

**ConsolidatedStatements of Shareholders’ Equity**

**For the years ended January 1,2005, January 3, 2004 and December 28, 2002**

(in thousands)

 
|                                           |   | **Total   Shareholders’  Equity** |   |   |   |   |   | **Additional  Paid-in  Capital** |   | **Deferred  Stock  Compensation** |   | **Retained  Earnings/  (Deficit)** |   | **Accumulated  Other  Comprehensive  Income/(loss)** |   | **Comprehensive  Income/  (loss)** |   |
|------------------------------------------------|--------|----------------------------------------|--------|--------|--------|--------|--------|----------------------------------|--------|-----------------------------------|--------|------------------------------------|--------|------------------------------------------------------|--------|------------------------------------|--------|
| ** **                                     |   | ** **                             |
| ** **                                     |   | ** **                             |
| **Common Stock**                               |
| **Shares**                                     |   | **Amount**                             |
| Balances at                                    |   |                                   |   |   |   |   |   |                             |   |                              |   |                               |   |                                                 |   |                               |   |
| December 29, 2001                         |   | $                                      | 19,274 |   | 5,000  |   | $      | 50                               |   | $                                 | 24,940 |                               | $      | —                                               |   | $                                  | (5,860 | ) | $ | 144 |   |   |   |
| Net loss                                       |   | (6,204                                 | )      |   |   |   |   |                             |   |                              |   | (6,204                             | )      |                                                 |   | $                                  | (6,204 | ) |
| Cumulative translation adjustment              |   | (274                                   | )      |   |   |   |   |                             |   |                              |   |                               |   | (274                                                 | )      | (274                               | )      |
| Comprehensive loss                             |   |                                   |   |   |   |   |   |                             |   |                              |   |                               |   |                                                 |   | $                                  | (6,478 | ) |
| Restricted stock awards                        |   |                                   |   | 84     |   |   |   | 157                              |   | (157                              | )      |                               |   |                                                 |   |                               |   |
| Amortization of deferred  compensation         |   | 33                                     |   |   |   |   |   |                             |   | 33                                |   |                               |   |                                                 |   |                               |   |
| Balances at December 28,  2002            |   | 12,829                                 |   | 5,084  |   | 50     |   | 25,097                           |   | (124                              | )      | (12,064                            | )      | (130                                                 | )      |                               |   |
| Net loss                                       |   | (3,868                                 | )      |   |   |   |   |                             |   |                              |   | (3,868                             | )      |                                                 |   | $                                  | (3,868 | ) |
| Cumulative translation adjustment              |   | (141                                   | )      |   |   |   |   |                             |   |                              |   |                               |   | (141                                                 | )      | (141                               | )      |
| Comprehensive loss                             |   |                                   |   |   |   |   |   |                             |   |                              |   |                               |   |                                                 |   | $                                  | (4,009 | ) |
| Stock incentive awards                         |   | 5                                      |   | 14     |   |   |   | 5                                |   |                              |   |                               |   |                                                 |   |                               |   |
| Restricted stock awards                        |   |                                   |   | 145    |   | 2      |   | 27                               |   | (29                               | )      |                               |   |                                                 |   |                               |   |
| Amortization of deferred  compensation         |   | 45                                     |   |   |   |   |   |                             |   | 45                                |   |                               |   |                                                 |   |                               |   |
| Balances at January 3,  2004              |   | 8,870                                  |   | 5,243  |   | 52     |   | 25,129                           |   | (108                              | )      | (15,932                            | )      | (271                                                 | )      |                               |   |
| Net earnings                                   |   | 12,375                                 |   |   |   |   |   |                             |   |                              |   | 12,375                             |   |                                                 |   | $                                  | 12,375 |   |
| Cumulative translation adjustment              |   | 11                                     |   |   |   |   |   |                             |   |                              |   |                               |   | 11                                                   |   | 11                                 |   |
| Comprehensive income                           |   |                                   |   |   |   |   |   |                             |   |                              |   |                               |   |                                                 |   | $                                  | 12,386 |   |
| Stock incentive awards                         |   | 23                                     |   | 10     |   |   |   | 23                               |   |                              |   |                               |   |                                                 |   |                               |   |
| Restricted stock awards,  net of cancellations |   |                                   |   | 84     |   | 1      |   | 399                              |   | (400                              | )      |                               |   |                                                 |   |                               |   |
| Amortization of deferred  compensation         |   | 101                                    |   |   |   |   |   |                             |   | 101                               |   |                               |   |                                                 |   |                               |   |
| Stock options exercised                        |   | 33                                     |   | 54     |   | 1      |   | 32                               |   |                              |   |                               |   |                                                 |   |                               |   |
| Tax benefit from stock options  excercised     |   | 9                                      |   |   |   |   |   | 9                                |   |                              |   |                               |   |                                                 |   |                               |   |
| Balances at January 1,  2005              |   | $                                      | 21,422 |   | 5,391  |   | $      | 54                               |   | $                                 | 25,592 |                               | $      | (407                                                 | )      | $                                  | (3,557 | ) | $ | (260 | ) |   |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

F-5

----

 

**National Vision, Inc.**

**ConsolidatedStatements of Cash Flows**

**Forthe years ended January 1, 2005 (Fiscal 2004),**

**January 3,2004 (Fiscal 2003) and December 28, 2002 (Fiscal 2002)**

(in thousands)

 
| ** **                                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                   |       |     |       |     |       |     |       |
| Cash flow from  operating activities:                  |       |     |       |     |       |     |       |
| Net income (loss)                                      |       | $        | 12,375     |     | $          | (3,868   | )          | $ | (6,204 | ) |
| Adjustments to  reconcile cash to net income (loss):   |       |     |       |     |       |     |       |
| Depreciation and  amortization                         |       | 13,542   |       | 15,962   |       | 18,999   |       |
| Impairment of  long-lived assets                       |       | 336      |       | 550      |       |     |       |
| Deferred income tax benefit                            |       | (1,203   | )          |     |       |     |       |
| Cumulative effect of a  change in accounting principle |       |     |       | 564      |       |     |       |
| Gain on repurchase of  subordinated notes              |       | (3,166   | )          | (2,321   | )          | (1,566   | )          |
| Loss (gain) on disposal  of equipment                  |       | 98       |       | (21      | )          |     |       |
| Other                                                  |       | 143      |       | 31       |       | 556      |       |
| Changes in operating  assets and liabilities:          |       |     |       |     |       |     |       |
| Accounts receivable                                    |       | 517      |       | (914     | )          | 1,744    |       |
| Inventories                                            |       | 3,322    |       | (23      | )          | 693      |       |
| Other current assets                                   |       | (1,127   | )          | 27       |       | 396      |       |
| Other assets                                           |       | (183     | )          | 15       |       | 71       |       |
| Accounts payable                                       |       | (60      | )          | 61       |       | (490     | )          |
| Accrued expenses and other  current liabilities        |       | (1,360   | )          | 739      |       | (1,075   | )          |
| Other non-current  liabilities                         |       | 491      |       |     |       |     |       |
| Net cash provided by  operating activities             |       | 23,725   |       | 10,802   |       | 13,124   |       |
| Cash flow from  investing activities:                  |       |     |       |     |       |     |       |
| Purchase of property  and equipment                    |       | (5,137   | )          | (4,517   | )          | (5,209   | )          |
| Proceeds from sale of  property and equipment          |       | 245      |       | 253      |       |     |       |
| Net cash used by  investing activities                 |       | (4,892   | )          | (4,264   | )          | (5,209   | )          |
| Cash flow from  financing activities:                  |       |     |       |     |       |     |       |
| Principal payments on  subordinated debt               |       | (2,551   | )          | (8,161   | )          | (5,796   | )          |
| Repurchases of  subordinated debt                      |       | (11,979  | )          | (3,702   | )          | (2,932   | )          |
| Proceeds from stock  option exercises                  |       | 34       |       |     |       |     |       |
| Deferred financing  costs                              |       | (24      | )          | (150     | )          |     |       |
| Advances on revolver                                   |       |     |       | 1,904    |       | 7,378    |       |
| Payments on revolver                                   |       |     |       | (1,904   | )          | (7,378   | )          |
| Principal payments on  other long-term debt            |       |     |       |     |       | (13      | )          |
| Net cash used by  financing activities                 |       | (14,520  | )          | (12,013  | )          | (8,741   | )          |
| Net increase (decrease)  in cash                       |       | 4,313    |       | (5,475   | )          | (826     | )          |
| Cash, beginning of year                                |       | 3,545    |       | 9,020    |       | 9,846    |       |
| Cash, end of year                                      |       | $        | 7,858      |     | $          | 3,545    |       | $ | 9,020 |   |
|                                                   |       |     |       |     |       |     |       |
| **Supplemental  cash flow information**                |       |     |       |     |       |     |       |
| Cash paid (received)  for:                             |       |     |       |     |       |     |       |
| Interest                                               |       | $        | 11,151     |     | $          | 13,292   |       | $ | 14,257 |   |
| Income taxes                                           |       | $        | 656        |     | $          | (204     | )          | $ | (1,243 | ) |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

F-6

----

 

**NationalVision, Inc.**

**Notes toConsolidated Financial Statements**

 

**1.  Organization and Operations**

 

National Vision,Inc. (the “Company”) is primarily engaged in the retail sale of optical goodsand related services.  We also operate ahealth maintenance organization (“HMO”) in California through which we provideeye examinations to the HMO’s members.

 

**2.  Significant Accounting Policies**

 

***Principles of Consolidation.***** **Theconsolidated financial statements include our accounts and those of oursubsidiaries, all of which are wholly-owned. Significant intercompany balances andtransactions have been eliminated in consolidation.

 

***Fiscal Year.***** **Ourfiscal year ends on the Saturday closest to December 31.  Accordingly, fiscal 2004 wasa 52-week period ended January 1, 2005, fiscal 2003 was a 53-week periodended January 3, 2004, and fiscal 2002 was a 52-week period ended December 28,2002.  Due to statutory and other considerations,our Mexican subsidiary does not operate on this 52/53 week calendar.  To allow for more timely consolidation andreporting, this subsidiary, which accounts for approximately 2% of netrevenues, is reported using a twelve-month period ending November 30.

 

***Reclassifications.***** **Certainamounts in the prior year financial statements have been reclassified toconform to the current year presentation.

 

***Discontinued Operations.***** **During2004, we closed 60 vision centers, two of which were relocated as freestandingstores.  During 2003 and 2002, we closed54 and one vision centers, respectively, none of which were reopened.  Also, in 2003, we closed eight HMO offices inCalifornia which did not reopen. Historical operating results for the closed vision centers that were notrelocated and the closed HMO offices are classified as discontinued operationsfor all periods presented.  Theseoperating results are classified as discontinued operations because the visioncenter locations are geographically dispersed, and in the case of our Wal-Martlocations, we believe the host opens a vision center in the space we vacate,and therefore, significant cash flows from the closed locations are notexpected to migrate to our remaining vision center operations.  Condensed information for these discontinuedoperations is presented below (in thousands):

 
| ** **                 | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|----------|------------|
|                       |       |     |       |     |       |     |       |
| Total net revenue          |       | $        | 13,970     |     | $          | 36,433   |       | $ | 49,198 |   |
| Operating income           |       | $        | 2,344      |     | $          | 2,204    |       | $ | 4,557 |   |
| Income (loss) on  disposal |       | $        | (57        | )        | $          | (146     | )          | $ | 7 |   |
| Income taxes               |       | $        | 35         |     | $          | 62       |       |   |   |   |

 

***Revenue Recognition.***** **Werecognize revenue from sales of optical products and services upon delivery ofthe product or services to the customer. Our retail customers generally make full payment for prescriptioneyewear products at the time they place an order, and we defer revenuerecognition associated with such transactions by estimating the amount ofproduct that has not been delivered to customers at the end of each accountingperiod.

 

Since May 2003, wehave offered an extended warranty which provides for repair and replacement ofeyeglasses during the first year after purchase.  Revenues from the sale of extended warrantycontracts are recognized on a straight-line basis over the life of thecontract.

 

Fees from managedcare vision services include premiums from the HMO’s managed care insuranceproduct and, commencing in 2004, patient co-payments for exam fees in excess ofthe benefit provided for such exams. Revenue from the HMO premium is recognized over the twelve-month life ofthe policy as services are rendered. Patient co-payments are recognized as revenue as the exam services areprovided.

 

F-7

----

 

A reconciliationof the changes in deferred revenue from the sale of warranty contracts and HMOpremiums is as follows (in thousands):

 
| ** **                        | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
| Deferred warranty  revenue:       |       |     |       |     |       |
| Beginning balance                 |       | $        | 2,680      |     |       |   |
| Warranty contracts sold           |       | 6,295    |       | $        | 4,684      |   |
| Amortization of  deferred revenue |       | (5,938   | )          | (2,004   | )          |
| Ending balance                    |       | $        | 3,037      |     | $          | 2,680 |   |

 
|                        |   | **2004** | ** ** | **2003** |   |
|-----------------------------|--------|----------|------------|----------|--------|
| Deferred premium  revenue:  |   |     |       |     |   |
| Beginning balance           |   | $        | 285        |     | $      | 48 |   |
| Premiums collected          |   | 7,408    |       |     | 6,608  |   |
| Premium revenue  recognized |   | (7,363   | )          | (6,371   | )      |
| Ending balance              |   | $        | 330        |     | $      | 285 |   |

 

***Cost of Goods Sold.* **We recognize the cost of products soldconcurrent with the recognition of revenue. Occupancy costs for our retail locations are included in cost of goodssold.

 

***Selling, General and AdministrativeExpense.*********Selling, general and administrative expenseincludes store operating expenses, excluding occupancy costs, depreciation andamortization, corporate office support and administrative expenses.

 

***Cash and Cash Equivalents.****** ***We consider cash on hand and short-term cash investmentsto be cash and cash equivalents.  Cashequivalents represent highly liquid investments with a maturity of one month orless.  We restrict such investments tofinancial institutions with high credit standings.

 

***Managed Care Accounts Receivable.***** **Managedcare accounts receivable are recorded net of contractual allowances and arereduced by an allowance for amounts that may become uncollectible.  A significant portion of our accountsreceivables is due from health care plans and programs located throughout theUnited States.  Estimates of ourallowance for uncollectible receivables are based on our historical collectionexperience and historical and current operating, billing and collection trends.

 

***Inventory.***** **Ourinventories are stated at the lower of weighted average cost or market.  Periodically, we receive purchase discountsor reduced pricing on inventory purchases. These reductions in the normal purchase price are accounted for in theweighted average cost of inventory.  Weclassify inventory as finished goods if such inventory is readily available forsale to customers without assembly or value-added processing.  Finished goods include contact lenses, overthe counter sunglasses and accessories. We classify inventory as raw materials if such inventory requiresassembly or value-added processing.  Thiswould include grinding a lens blank, cutting the lens in accordance with aprescription from an optometrist and fitting the lens in a frame.  Frames and uncut lenses are considered rawmaterials.  Work in progress includesspectacle orders that are being processed in either of our centralized labfacilities.

 

In most cases, the expected sales value (i.e., market value) of ourinventory is higher than its cost. However, as we strategically change our frame and lens selection fromtime to time, discontinued merchandise may be removed from stores and returnedto the distribution center or it may be marked as promotional merchandise andsold at a lower price.  As a result,there is a high degree of judgment and complexity in determining the marketvalue of such inventories.  For inventoryon hand, we estimate the future selling price of our merchandise, given itscurrent selling price and planned promotional activities, and provide a reservefor the difference between cost and the expected selling price for all itemsexpected to be sold below cost.

 

At the beginning of fiscal 2003, we adopted Emerging Issues Task ForceIssue No. 02-16, “Accounting by a Customer for Certain Consideration Receivedfrom a Vendor” (“EITF 02-16”).  As a result of the adoption of EITF 02-16, certain vendor allowances are now presented asa reduction of inventory cost and subsequently as a component of cost of goodssold.

 

F-8

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We conduct physical inventory counts for all of our store locations atleast twice per year and adjust our records to reflect the actual inventorycounts.  Cycle counts are performedweekly for inventory in our distribution centers and laboratory facilities, andall inventory in our distribution centers andlaboratory facilities is counted near the end of the fiscal year.  As all locations are not counted as of ourreporting dates, we provide a reserve for inventory shrinkage based principallyon historical inventory shrinkage experience.

 

***Property and Equipment.***** **Propertyand equipment are stated at cost.  Forfinancial reporting purposes, depreciation is computed using the straight-linemethod over the assets’ estimated useful lives or terms of the related leases,whichever is shorter.  Accelerateddepreciation methods are used for income tax reporting purposes.  For financial reporting purposes,depreciation periods range from five to ten years for equipment, three to nineyears for furniture and fixtures, three to six years for hardware and softwarerelated to information systems processing, and five to nine years for leaseholdimprovements.  At the time property andequipment are retired, the cost and related accumulated depreciation are removedfrom the accounts and any gain or loss is credited or charged to income.  Maintenance and repairs are charged toexpense as incurred.  Replacements andimprovements are capitalized.

 

***Balance Sheet Financial Instruments: Fair Values.* **The carrying amounts reported in theconsolidated balance sheets for cash and cash equivalents, accounts receivable,accounts payable, accrued liabilities and current portion of long-term debtapproximate fair value because of the immediate or short-term maturity of thesefinancial instruments.

 

The fair value ofour long-term debt, determined using the weighted average price of the mostrecent trades made during the last quarter of the fiscal years ending January 1,2005 and January 3, 2004, was as follows (in thousands):

 
| ** **                              | ** ** | **Carrying  Value** | ** ** | **Fair  Value** | ** ** |
|-----------------------------------------|------------|---------------------|------------|-----------------|------------|
|                                    |       |                |       |            |       |
| Long-term debt at January 1,  2005 |       | $                   | 72,930     |            | $          | 72,930 |   |
| Long-term debt at January 3,  2004 |       | $                   | 94,939     |            | $          | 57,934 |   |

 

Financialinstruments which potentially subject us to concentrations of credit riskconsist principally of trade accounts receivable.  The credit risk is limited due to the largenumber of individuals and entities comprising our customer base.

 

***Intangible Value Of ContractualRights.* **Our mostsignificant intangible asset is the Intangible Value of Contractual Rights,which was initially recorded upon our emergence from bankruptcy.  This intangible asset represents the valueupon emergence from bankruptcy of the Company’s license agreement with Wal-Martand the business relationship therein created. Based on our projections, our best estimate of the useful life of thisasset was 15 years at inception and is 11 years and 5 months at January 1, 2005.  Due to the uncertainty involved in predictingthe pattern of economic benefits realized from the Wal-Mart relationship, weamortize this asset using the straight-line method.  Amortization expense on the Intangible Valueof Contractual Rights was $7.5 million in 2004 and 2003, and $7.6 million in2002.  Future amortization expense willbe $7.5 million per year for each of the five succeeding years.

 

We emerged frombankruptcy on May 31, 2001.  During 2003and 2002, we realized net income tax benefits of $159,000 and $712,000,respectively, generated prior to the reorganization.  These benefits were recorded as reductions inthe value of the Intangible Value of Contractual Rights.

 

***Impairment of Long-Lived Assets.***We assess the impairment of all identifiable intangibles and long-lived assetson an annual basis and whenever events or changes in circumstances indicatethat the carrying value may not be recoverable. Factors we consider important, which could trigger an impairment review,include a significant underperformance of vision center operations relative toexpected historical or projected future operating results and a permanentadverse change in cash flows generated by an operation.

 

Based upon theexistence of one or more of the above indicators of impairment, we determine ifthe carrying value of intangibles or long-lived assets may not be recoverablebased on a projected cash flow model.  Ifthe projected undiscounted cash flows are not in excess of the book value ofthe related asset, we adjust the carrying value of the long-term assets totheir fair market value.  Our estimate ofthe fair market value of our retail locations is generally limited to theamount we expect to recover upon ultimate sale of equipment utilized at eachlocation.

 

F-9

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***Income Taxes.***** **  Deferred income taxes are provided for thefuture tax benefits to be derived from the utilization of tax losscarry-forwards and the tax effect of items of income and expense that arerecognized in different periods for financial and tax reporting purposes, suchas depreciation and amortization, inventory basis differences, and certainaccrued expenses.  Deferred income taxesare computed using enacted tax rates in effect for the year in which thedifferences are expected to reverse.

 

A valuationallowance is recorded against any net deferred tax assets if it is “more likelythan not” that we will not ultimately realize the benefit of the net deferredtax asset.  Due to uncertainties concerningrealizations of the deferred tax assets that existed during both 2003 and 2002based on losses incurred in those years, we provided a full valuation allowancefor the net deferred tax asset.  During2004, our income before income taxes was $11.6 million and we estimate that ourfederal taxable income will be more than $20 million for such year.  Further, we expect future profitability fromcontinuing operations.  At January 1,2005, we reassessed our situation and were no longer able to conclude that itwas “more likely than not” that we would not eventually realize the taxbenefits of our net operating loss carry-forwards.  Accordingly, we reversed the remainingvaluation allowance of $1,203,000 effective on January 1, 2005.

 

F-10

----

 

***Accounting forStock Options.****** ***Weapply the disclosure provisions of SFAS No. 123,“Accounting for Stock-Based Compensation.” Stock option awards continue to beaccounted for in accordance with APB Opinion No. 25. The number of shares to beissued and the per share strike price are not subject to uncertainty;accordingly our stock option grants qualify for fixed accounting treatment.  As a result, we do not record compensationexpense in connection with the granting of these stock options.

 

Hadcompensation cost for the employee and non-employee director stock options beendetermined based on the fair value at the grant date for awards in 2004, 2003and 2002 consistent with the provisions of SFAS No.123, our net earnings and earnings per share would have been reduced to the proforma amounts indicated below (amounts in thousands except per shareinformation):

 
| ** **                                     | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| As reported:                                   |       |     |       |     |       |     |       |
| Net earnings (loss)                            |       | $        | 12,375     |     | $          | (3,868   | )          | $ | (6,204 | ) |
| Pro Forma:                                     |       |     |       |     |       |     |       |
| Compensation expense                           |       | 130      |       | 68       |       | 53       |       |
| Pro forma:                                     |       |     |       |     |       |     |       |
| Net earnings (loss)                            |       | $        | 12,245     |     | $          | (3,936   | )          | $ | (6,257 | ) |
|                                           |       |     |       |     |       |     |       |
| Basic earnings (loss)  per share as reported   |       | $        | 2.43       |     | $          | (0.77    | )          | $ | (1.24 | ) |
| Pro forma compensation  expense per share      |       | (0.03    | )          | (0.02    | )          | (0.01    | )          |
| Pro forma earnings  (loss) per share           |       | $        | 2.40       |     | $          | (0.79    | )          | $ | (1.25 | ) |
|                                           |       |     |       |     |       |     |       |
| Diluted earnings (loss)  per share as reported |       | $        | 2.20       |     | $          | (0.77    | )          | $ | (1.24 | ) |
| Pro forma compensation  expense per share      |       | (0.02    | )          | (0.02    | )          | (0.01    | )          |
| Pro forma earnings  (loss) per share           |       | $        | 2.18       |     | $          | (0.79    | )          | $ | (1.25 | ) |

 

Thefair value of each option grant is estimated on the date of grant using theBlack-Scholes option-pricing model.  The following weighted average assumptionswere used in the model:

 
| ** **                | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|
|                      |       |     |       |     |       |     |       |
| Dividend yield            |       | 0.0      | %          | 0.0      | %          | 0.0      | %          |
| Expected volatility       |       | 372.0    | %          | 410.0    | %          | 172.0    | %          |
| Risk free interest  rates |       | 3.5      | %          | 2.6      | %          | 3.0      | %          |
| Expected lives (years)    |       | 6.3      |       | 5        |       | 3.4      |       |

 

 

***Other Assets and Deferred Costs.***** **Otherassets and deferred costs include capitalized financing costs which are beingamortized using a method that approximates the effective interest yield methodover periods that correspond with the terms of the underlying debt.

 

***Self-Insurance Accruals.***** **Weself-insure estimated costs associated with workers’ compensation claims andgroup medical liabilities, up to certain limits.  Insurance reserves are established based onactuarial estimates of the loss that we will ultimately incur on reportedclaims, as well as estimates of claims that have been incurred but not yetreported.  Trends in actual experienceare a significant factor in the determination of such reserves.

 

***Advertising and Promotion Expense.***** **Advertisingand promotion costs are expensed at the time such materials are firstdistributed or broadcast.  Productioncosts of future media advertising and related promotion campaigns are deferreduntil the advertising events first occur. Advertising expense for 2004, 2003 and 2002 was approximately $3.8million, $3.5 million and $3.2 million, respectively, net of cooperativeadvertising payments of $0.4 million, $0.3 million and $0.5 million,respectively, received from our vendors in those years.

 

***Cumulative Effect of a Change inAccounting Principle.******* **Weadopted Emerging Issues Task Force Issue No. 02-16, “Accounting by a Customerfor Certain Consideration Received from a Vendor” (“EITF02-16”) at the beginning of 2003.  ThisIssue addresses the method by which retailers account for vendor allowances.Prior to fiscal 2003, vendor allowances received under co-op advertisingagreements were classified in the income statement as a reduction inadvertising expense.  As a result of theadoption of EITF 02-16, most vendor allowances arenow presented as a reduction of inventory cost and subsequently as a componentof cost of goods sold.  On the first dayof fiscal 2003, we recorded additional expense of $564,000 as the cumulativeeffect of this change in accounting principle. This amount reflects the portion of vendor allowances that would havereduced inventory costs had this new accounting pronouncement been in effect in2002.

 

F-11

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***Foreign Currency Translation.******* **Assets and liabilities of our Mexicansubsidiary are translated into U.S. dollars using exchange rates in effect atthe end of the reporting period; income and expenses are translated using theaverage exchange rates for the reporting period.  Translation gains or losses are deferred andshown as a separate component of shareholders’ equity.

 

***Other Comprehensive Income.***** **Othercomprehensive income is defined as net income and other changes in stockholders’equity from transactions other than those involving stockholders and netincome.  Our only source of othercomprehensive income is the translation adjustment from our operations inMexico.

 

***Use of Estimates.******* **The preparation of financial statements inaccordance with accounting principles generally accepted in the United Statesof America requires us to make estimates and assumptions that affect thereported amounts of assets and liabilities and the disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period.

 

On an ongoingbasis, we evaluate our estimates and judgments and incorporate any changes insuch estimates and judgments into the accounting records underlying ourconsolidated financial statements.  Webase our estimates and judgments on historical experience and on various otherfactors that are believed to be reasonable under the circumstances, the resultsof which form the basis for making judgments about the carrying values of assetsand liabilities that are not readily apparent from other sources.  Actual results may differ from theseestimates under different assumptions or conditions.

 

**3.  Recent Accounting Pronouncements**

 

In December 2004,the Financial Accounting Standards Board (“FASB”)issues Statement No. 123(R), *Share-BasedPayments*, which will require compensation costs related toshare-based payment transactions to be recognized in the financialstatements.  As permitted by thepredecessor Statement No. 123, we do not recognize compensation expense withrespect to stock options we have issued because the option price was no greaterthan the market price at the time the option was issued.  Statement 123(R) will be effective for us inour fiscal quarter beginning July 3, 2005. We have not completed an evaluation of the impact of adopting Statement123(R).

 

In November 2004,the FASB ratified the Emerging Issues Task Force (“EITF”) consensus on Issue 03-13, “*Applying the Conditions in Paragraph 42 of FASB Statement No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets,” in Determining Whether to Report DiscontinuedOperations,*which is effective for us at the beginning of fiscal2005.  We are already in conformity withthis new pronouncement; therefore, implementation will not impact our financialstatements.

 

In November 2004,the FASB issued Statement No. 151, *Inventory Costs, an amendment of ARBNo. 43, Chapter 4,* to clarifythat abnormal amounts of idle facility expense, freight, handling costs andwasted material (spoilage) should be recognized as current period charges, andthat fixed production overheads should be allocated to inventory based onnormal capacity of production facilities. Statement No. 151 will be effective for our fiscal year beginning January 1,2006, and its adoption will not have a material impact on our financialposition or results of operations.

 

**4.  Wal-Mart Master License and Other Agreements**

 

At January 1,2005, we operated 304 vision centers in domestic Wal-Mart stores pursuant to amaster license agreement.  Each visioncenter covered by the Wal-Mart agreement has a separate base lease term of nineyears with a renewal option for one additional three-year term.  Percentage license fees remain the same overthe nine-year base term and three-year option term, whereas minimum licensefees increase during the three-year option term.

 

In 1994, we openedour first eight vision centers in stores owned and operated by Wal-Mart deMexico, S.A. de C.V. (Wal-Mart de Mexico). Wecompleted the negotiation of a master license agreement governing these visioncenters in 1995.  Pursuant to thisagreement, each vision center has an individual base term of five years fromthe date of opening, followed by two options (each for two years), and one optionfor one year.  Each party has the rightto terminate a location which fails to meet specified sales levels.  The agreement provides for annual fees basedon a percentage of sales.  The agreementalso gives us a right of first refusal to open vision centers in all stores inMexico owned by Wal-Mart de Mexico.  Asof January 1, 2005, we operated 35 vision centers in Wal-Mart de Mexicostores.

 

At January 1,2005, we operate 47 leased vision centers in stores owned by Fred Meyer, all ofwhich operate pursuant to a master license agreement.  The agreement provides for base andpercentage rent and other customary terms and conditions.  The agreement expires on December 31,2006.

 

F-12

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We operate 28leased vision centers on military bases, each of which operates pursuant to aseparate lease agreement.  Theseagreements provide for percentage rent and other customary terms andconditions.

 

For our domesticvision centers, we amortize leasehold improvements over the base term of thelease on a straight line basis.  For ourWal-Mart vision centers, we do not make the decision to exercise the three-yearrenewal option until approximately six months prior to the expiration of thebase lease term.  For our freestandinglocations, we will make the decision to renew at the time specified in theseparate lease agreements.

 

For all of ourleases which require a minimum or base rent, we charge the total minimum orbase rent to be paid over the base term of the lease to expense, on a straightline basis, over the period from date of possession, which is generally earlierthan the lease start date, to the end of the base lease term.

 

**5.  Inventory**

 

Inventorybalances, by classification, are summarized as follows (amounts in thousands):

 
| ** **                          | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
|                                |       |     |       |     |       |
| Raw materials and work  in progress |       | $        | 9,206      |     | $          | 11,195 |   |
| Finished goods                      |       | 5,796    |       | 6,961    |       |
| Supplies                            |       | 356      |       | 485      |       |
| Reserves                            |       | (1,293   | )          | (1,254   | )          |
|                                |       | $        | 14,065     |     | $          | 17,387 |   |
|                                     |            |          |            |          |            |  |  |  |  |

 

**6.  Long-Term Debt**

 

***Fleet Facility.******* **In December 2003, we amended ourcredit facility with Fleet Retail Group, Inc. (the “Fleet Facility”).  This amendment extended the term of theprevious credit facility from an expiration date of May 30, 2004 to anexpiration date of May 30, 2007.  Theamendment also effectively increased availability by approximately $3.5 millionand allowed us to repurchase Notes within certain limitations.  The Fleet Facility bears interest at theprime rate plus 0.75% per annum or at LIBOR plus 3.0%, and providesavailability of an estimated $10 million, subject to borrowing base limitationsand inclusive of letter of credit requirements. At January 1, 2005, we had $2.9 million of unused availabilityunder the Fleet Facility.  Any borrowingsunder the Fleet Facility are secured by substantially all of our assets.  The Fleet Facility contains variousrestrictive covenants and requires us to maintain minimum levels of EBITDA (as defined) and a minimum fixed charge coverageratio (as defined) of 1.0 to 1.0 and limits the amount of our capitalexpenditures and certain non-host lease payment obligations.  We did not borrow any amounts under thisfacility during the year ended January 1, 2005.  Our weighted average interest rate under theFleet Facility was 4.87%, and 5.43% for the years ended January 3, 2004and December 28, 2002, respectively. At January 1, 2005 and at January 3, 2004 we had nooutstanding borrowings under the Fleet Facility.

 

We are party toletters of credit issued under the Fleet Facility totaling $4.0 million and$4.3 million at January 1, 2005 and January 3, 2004,respectively.  Management does not expectany material losses to result from these off-balance-sheet instruments becauseperformance is not expected to be required.

 

***Senior Subordinated Notes.******* **Our Senior Subordinated Notes provide forthe payment of interest at an annual rate of 12% twice a year at the end of March andSeptember, are subordinated to debt under the Fleet Facility and are secured bysubstantially all of our assets.  TheSenior Subordinated Notes contain various restrictive covenants including aprohibition from our paying dividends. These Notes are due in 2009; however, principal repayments (“Excess CashRepayments”) are required semi-annually at the end of February and August basedon excess cash flow (as defined) for the six month periods ending in thepreceding June and December, respectively. As a result, we made an Excess Cash Repayment of approximately $4.9million on February 28, 2005.  Thisamount is classified as current at January 1, 2005.  As future principal repayments are contingentupon future cash flows, the only portion reflected as a current liability isthe repayment that is based on financial results reported herein.

 

F-13

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Long-term debtobligations at January 1, 2005 and January 3, 2004 consisted of thefollowing (amounts in thousands):

 
| ** **                              | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|
|                                    |       |     |       |     |       |
| 12% Senior Subordinated  Notes due 2009 |       | $        | 77,788     |     | $          | 95,484 |   |
| Less current portion                    |       | 4,858    |       | 545      |       |
| Total long-term debt                    |       | $        | 72,930     |     | $          | 94,939 |   |

 

SeeNote 2 “Significant Accounting Policies - Balance Sheet Financial Instruments:Fair Values” for the fair value estimate of the long-term debt at January 1,2005.

 

**7.  Impairment of Long Lived Assets**

 

We recordedimpairment losses of $336,000 in 2004 and $550,000 in 2003 as a result ofanalyzing the unprofitable operations in several of our retail locations.  In 2004, we closed 19 of the locations uponwhich we had recorded an impairment loss in 2003.  Accordingly, a portion of the 2003 impairmentloss is included in Discontinued Operations in the current year financialstatements.  Impairment losses for storesin continuing operations are included in selling, general and administrativeexpenses.  Our impairment losses aresummarized as follows (in thousands):

 
| ** **                                               | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                     |       |     |       |     |       |
| Included in selling,  general and administrative expense |       | $        | 336        |     | $          | 262 |   |
| Included in results of  discontinued operations          |       |     |       | 288      |       |
| Total                                                    |       | $        | 336        |     | $          | 550 |   |

 

**8.  Restructuring Expense**

 

During August 2003,we completed a restructuring of our retail field management organization andour home office retail support center. The process resulted in an approximately 15% reduction in headcountacross theses two areas.  Involuntarytermination benefits and outplacement costs of $484,000 recognized inconnection with this 2003 restructuring are included in selling, general andadministrative expenses for that year.

 

**9.  Reorganization Reserve**

 

We emerged from a Chapter 11 bankruptcy reorganization proceeding on May31, 2001.  On that date, we adopted “freshstart” accounting and adjusted the recorded value of all of our assets andliabilities to their then-current fair values. We also recorded a reorganization reserve to provide for all costs ofthe reorganization that had not yet been paid or incurred through May 31,2001.  The reserve was fully consumed in2003.  Activity in the reorganizationreserve during 2002 and 2003 was as follows (amounts in thousands):

 
| ** **                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
|                          |       |     |       |     |       |
| Balance at beginning of  year |       | $        | 248        |     | $          | 1,225 |   |
| Amounts paid                  |       | (248     | )          | (605     | )          |
| Write-off of invalid  claims  |       |     |       | (372     | )          |
| Balance at end of year        |       | Nil      |       | $        | 248        |   |
|                               |            |          |            |          |            |  |  |

 

**10.  Income Taxes**

 

The components ofthe net deferred tax assets are as follows (in thousands):

 

F-14

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| ** **                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
|                            |       |     |       |     |       |
| Total deferred tax  assets      |       | $        | 34,070     |     | $          | 39,698 |   |
| Total deferred tax  liabilities |       | (32,867  | )          | (35,462  | )          |
| Valuation allowance             |       | —   |       | (4,236   | )          |
| Net deferred tax asset          |       | $        | 1,203      |     | $          | — |   |

 

In 2003, thevaluation allowance was recorded due to uncertainties surrounding our ultimateability to utilize the full amount of our usable net operating losscarry-forwards which are recorded as deferred tax assets.  The valuation allowance was reversed atJanuary 1, 2005 because we were no longer able to conclude that it was “morelikely than not” that the net deferred tax asset would not be realized.  This conclusion was based upon thesubstantial improvement in our 2004 operating results and expected futureprofitability from continuing operations.

 

The sources of the difference between the financial accounting and taxbasis of our liabilities and assets which give rise to the deferred taxliabilities and deferred tax assets and the tax effects of each are as follows(in thousands):

 
| ** **                           | ** ** | **2004**    | ** ** | **2003**        | ** ** |
|--------------------------------------|------------|-------------|------------|-----------------|------------|
| ** **                           | ** ** | **Current** | ** ** | **Non-current** | ** ** | **Current** | ** ** | **Non-current** | ** ** |
|                                 |       |        |       |            |       |   |   |   |   |
| Property and equipment               |       | $           | —     |            | $          | 3,799 |   | $ | — |   | $ | 3,114 |   |
| Accrued expenses and  reserves       |       | 2,920       |       | 31              |       | 2,485 |   | — |   |
| Inventory                            |       | 274         |       | —          |       | 181 |   | — |   |
| Net operating loss  carry-forwards   |       | 4,800       |       | 18,601          |       | 3,836 |   | 26,345 |   |
| Intangible value of  contract rights |       | —      |       | (32,850         | )          | — |   | (35,446 | ) |
| Other                                |       | 1,400       |       | 2,228           |       | 1,678 |   | 2,044 |   |
| Valuation allowance                  |       | —      |       | —          |       | (875 | ) | (3,362 | ) |
| Deferred tax asset /  (liability)    |       | $           | 9,394      |            | $          | (8,191 | ) | $ | 7,305 |   | $ | (7,305 | ) |

 

The valuationallowance was increased by a net total of $1.5 million and $1.6 million in 2003and 2002, respectively, and reduced by a total of $4.2 million in 2004.

 

Income tax expensefrom continuing operations differs from the amounts resulting from multiplyingnet earnings (loss) before income taxes, discontinued operations and thecumulative effect of a change in accounting principle by the statutory federalincome tax rate for the following reasons (in thousands):

 
| ** **                                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                          |       |     |       |     |       |     |       |
| Federal income  tax/(benefit) provision at statutory rate     |       | $        | 3,255      |     | $          | (1,948   | )          | $ | (3,661 | ) |
| State income taxes, net  of federal income tax benefit        |       | 63       |       | 62       |       | —   |       |
| Change in deferred tax  asset valuation allowance             |       | (3,631   | )          | 2,151    |       | 3,236    |       |
| Other, net                                                    |       | (509     | )          | (129     | )          | 425      |       |
| Net income tax  provision applicable to continuing operations |       | $        | (822       | )        | $          | 136      |       | $ | — |   |

 

The 2004 netincome tax provision applicable to continuing operations consists of aprovision of $381,000 for taxes currently due offset by the $1,203,000 reversalof the remaining balance in the deferred tax valuation allowance at January 1,2005. The 2003 net income tax provision applicable to continuing operations consistsentirely of taxes currently due.

 

At January 1,2005, we had U.S. regular tax net operating loss carry-forwards ofapproximately $61 million that can reduce future federal income taxes.  If not utilized, these carry-forward creditsare scheduled to expire as follows:

 
| 2009 |   | $      | 2,130  |   |
|------|--------|--------|--------|--------|
| 2010 |   | 2,736  |   |
| 2019 |   | 846    |   |
| 2020 |   | 2,607  |   |
| 2021 |   | 52,782 |   |

 

The Company alsohad non-expiring alternative minimum tax credit carry-forwards of approximately$543,000 available to offset future regular taxes.  Utilization of our net operating loss andalternative minimum tax credit carry-forwards could be limited in the event ofa greater than 50% change in our stock ownership.  The limitation would be based on the stockvalue and the federal exempt tax rate on the date of ownership change.  These limitations could create a cap on theamount of the

 

F-15

----

 

NOLsthat would be deductible each year going forward until the amount is depletedor the time limitation on the NOLs expires.

 

Our Mexicansubsidiary pays the greater of an income tax or an asset tax.  Because we have operating losses in Mexico,we pay no income tax, but are subject to the asset tax.  Therefore, no provision for income taxes hasbeen made for our operations in Mexico.

 

F-16

----

 

**11.  Earnings per Common Share**

 

Basic earnings percommon share are computed by dividing net income by the weighted average numberof common shares outstanding during the year. Diluted earnings per common share are computed as basic earnings per commonshare, adjusted for the effect of all potential common stock equivalentshares.  The computation for basic anddiluted earnings per common share (“EPS”) is summarized as follows (amounts inthousands except per share information):

 
| ** **                                                                                                     | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net earnings (loss)  before discontinued operations and cumulative effect of a change in  accounting principle |       | $        | 10,123     |     | $          | (5,300   | )          | $ | (10,768 | ) |
| Earnings from  discontinued operations                                                                         |       | 2,252    |       | 1,996    |       | 4,564    |       |
| Earnings (loss) before  cumulative effect of a change in accounting principle                                  |       | 12,375   |       | (3,304   | )          | (6,204   | )          |
| Cumulative effect of a  change in accounting principle                                                         |       |     |       | (564     | )          |     |       |
| Net earnings (loss)                                                                                            |       | $        | 12,375     |     | $          | (3,868   | )          | $ | (6,204 | ) |
|                                                                                                           |       |     |       |     |       |     |       |
| Weighted average shares  outstanding for basic EPS                                                             |       | 5,102    |       | 5,032    |       | 5,000    |       |
| Net effect of dilutive  stock options and restricted stock awards                                              |       | 504      |       |     |       |     |       |
| Weighted average shares  outstanding for diluted EPS                                                           |       | 5,606    |       | 5,032    |       | 5,000    |       |
|                                                                                                           |       |     |       |     |       |     |       |
| Net earnings (loss) per  basic share:                                                                          |       |     |       |     |       |     |       |
| Earnings (loss) before  discontinued operations and cumulative effect of a change in accounting  principle     |       | $        | 1.99       |     | $          | (1.05    | )          | $ | (2.15 | ) |
| Earnings from  discontinued operations                                                                         |       | 0.44     |       | 0.39     |       | 0.91     |       |
| Earnings (loss) before  cumulative effect of a change in accounting principle                                  |       | 2.43     |       | (0.66    | )          | (1.24    | )          |
| Cumulative effect of a  change in accounting principle                                                         |       |     |       | (0.11    | )          |     |       |
| Net earnings (loss) per  basic share                                                                           |       | $        | 2.43       |     | $          | (0.77    | )          | $ | (1.24 | ) |
|                                                                                                           |       |     |       |     |       |     |       |
| Net earnings (loss) per  diluted share:                                                                        |       |     |       |     |       |     |       |
| Earnings (loss) before  discontinued operations and cumulative effect of a change in accounting  principle     |       | $        | 1.81       |     | $          | (1.05    | )          | $ | (2.15 | ) |
| Earnings from  discontinued operations                                                                         |       | 0.40     |       | 0.39     |       | 0.91     |       |
| Earnings (loss) before  cumulative effect of a change in accounting principle                                  |       | 2.21     |       | (0.66    | )          | (1.24    | )          |
| Cumulative effect of a  change in accounting principle                                                         |       |     |       | (0.11    | )          |     |       |
| Net earnings (loss) per  diluted share                                                                         |       | $        | 2.21       |     | $          | (0.77    | )          | $ | (1.24 | ) |

 

For the yearsended January 3, 2004 and December 28, 2002, respectively, stockoptions and unvested restricted shares of 129,189 and 214,370 are excluded fromthe calculation of diluted earnings per common share due to their anti-dilutiveeffect.

 

F-17

----

 

**12.  Shareholders’ Equity**

 

***The 2004 Equity Incentive Plan.***** **During2004, upon receiving the approval of our shareholders, we adopted the 2004Equity Incentive Plan (the “Plan”).  ThePlan replaced our Restated Stock Option and Incentive Award Plan and ourRestated Non-Employee Director Stock Option Plan, both of which wereterminated.  Awards granted under thesepredecessor plans remained outstanding under the terms and conditions of suchoriginal awards.

 

Under the Plan,the Compensation Committee of our Board of Directors may issue one or more ofthe following:  incentive stock options, non-qualifiedstock options, stock appreciation rights, restricted stock, restricted stockunits and performance shares.

 

On June 29, 2004, the Compensation Committee issued 107,500restricted shares and 50,000 options under the 2004 Equity Plan.  The restricted shares were issued tomanagement, and each of the five members of the Board of Directors receivedoptions covering 10,000 shares.  Of therestricted shares issued, 5,000 were cancelled during the third quarter of2004, leaving 102,500 outstanding at January 1, 2005, of which, 51,250vest on the third anniversary of the grant date.  The remaining 51,250 veston the fifth anniversary of the grant date with accelerated vesting if theCompany achieves certain financial goals.  Unamortized deferred compensation expensewith respect to the restricted shares amounted to approximately $373,000 at January 1,2005.  The options were issued at anexercise price equal to the fair market value on the date of grant.  The options vest at the rate of 50% on thefirst anniversary of the grant date, and 25% on each of the second and thirdanniversaries of the grant date.  At January 1,2005, a total of 562,275 options and 312,650 restricted shares were outstandingunder the Plan.  Also at January 1,2005, there were 247,240 shares available for grant under the Plan.  Mr. James W. Krause, a member of the Board ofDirectors and our former President and Chief Executive Officer, holds an optioncovering 11,250 shares that had vested at the time he retired from employmentwith the Company.  Pursuant to hisseparation agreement with us, Mr. Krause may exercise this option during thetime he serves as a member of our Board of Directors and for one year after heceases to serve as a member of the Board.

 

On September 14, 2004, the Compensation Committee issued 1,500restricted shares to an employee.  Theseshares vest on the third anniversary of the grant date.  Unamortized deferred compensation expense withrespect to the restricted stock amounted to approximately $5,000 at January 1,2005 and is being amortized over the three-year vesting period.

 

In July 2003,the Compensation Committee granted 168,000 shares of restricted stock tocertain employees.  Of these shares,43,750 were cancelled prior to year end in connection with employeeterminations.  The shares vest one-thirdeach year over the subsequent three years of continued employment.  Unamortized deferred compensation expensewith respect to the restricted stock amounted to approximately $26,000 at January 1,2005 and is being amortized over the three year vesting period.

 

In April 2002,the Compensation Committee issued 84,400 shares of restricted stock to ourcurrent President and Chief Executive Officer. The shares vest one-third each year over the subsequent three years ofcontinued employment.  Unamortizeddeferred compensation expense with respect to the restricted stock amounted toapproximately $3,000 at January 1, 2005 and is being amortized over thethree-year vesting period.

 

In October 2001,the Compensation Committee (the “Committee”) granted performance awards tocertain officers of the Company.  In April 2002,the Committee granted a performance award to our chief executive officer.  The performance awards provide for theissuance of award units on the basis of the determination by the Committee thatthe Company has attained defined financial results.  Under the terms of the performance awards,there are three performance periods: fiscal 2002, fiscal 2002-2003, and fiscal2002-2004.  Award units are payable two-thirdsin cash and one-third in common stock. The cash portion is payable at the greater of $5.00 per unit or theclosing trading price of common stock as of the last day of the performanceperiod.  We accrue compensation expensefor the awards over the related service period. We recorded compensation expense of $1,461,000, $201,000 and $143,000for the years ended January 1, 2005, January 3, 2004 and

 

F-18

----

 

December 28,2002, respectively. In 2004, we paid a total of approximately $103,000 to the holders of theperformance awards and issued a total of 9,437 shares of common stock to suchholders for the fiscal 2002-2003 performance period.  In 2003, we paid a total of approximately$143,000 to the holders of the performance awards and issued a total of 14,272shares of common stock to such holders for the 2002 performance period.

 

F-19

----

 

In 2004, 2003, and2002, the exercise prices for options granted were equal to the closing marketprice of the Common Stock on the date of grant. Stock option transactions during the three years ended January 1,2005 were as follows:

 
| ** **                                 | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                       |       |     |       |     |       |     |       |
| Options outstanding  beginning of period   |       | 498,200  |       | 539,450  |       | 348,750  |       |
| Options granted                            |       | 139,000  |       | 50,000   |       | 223,600  |       |
| Options cancelled                          |       | (20,799  | )          | (91,250  | )          | (32,900  | )          |
| Options exercised                          |       | (54,126  | )          |     |       |     |       |
| Options outstanding end  of period         |       | 562,275  |       | 498,200  |       | 539,450  |       |
|                                       |       |     |       |     |       |     |       |
| Options exercisable end  of period         |       | 173,204  |       | 129,393  |       |     |       |
|                                       |       |     |       |     |       |     |       |
| Weighted average option  prices per share: |       |     |       |     |       |     |       |
| Granted                                    |       | $        | 2.057      |     | $          | 0.760    |       | $ | 0.830 |   |
| Cancelled                                  |       | $        | 0.400      |     | $          | 0.400    |       | $ | 0.400 |   |
| Exercised                                  |       | $        | 0.608      |     |       |     |       |   |
| Outstanding at year end                    |       | $        | 0.993      |     | $          | 0.615    |       | $ | 0.580 |   |
| Options exercisable end  of period         |       | $        | 0.676      |     | $          | 0.568    |       |   |   |

 

The followingtable shows the options outstanding and the options exercisable with pertinentdata related to each at January 1, 2005:

 
| ** **                    | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                             | ** ** |
|-------------------------------|------------|-------------------------|------------|-----------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Number  Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|                          |       |                    |       |                                                |       |   |   |   |   |   |   |
| $0.40 -$0.40                  |       | 165,475                 |       | 8.20                                                |       | $ | 0.400 |   | 46,604 |   | $ | 0.400 |   |
| $0.60 -$0.75                  |       | 174,600                 |       | 7.30                                                |       | $ | 0.742 |   | 116,400 |   | $ | 0.742 |   |
| $0.76 -$1.00                  |       | 53,000                  |       | 8.58                                                |       | $ | 0.774 |   |   |   |   |   |
| $1.18 -$1.77                  |       | 97,200                  |       | 8.73                                                |       | $ | 1.587 |   | 10,200 |   | $ | 1.180 |   |
| $2.30 -$2.38                  |       | 72,000                  |       | 9.36                                                |       | $ | 2.324 |   |   |   |   |   |
|                          |       | 562,275                 |       | 8.20                                                |       | $ | 0.993 |   | 173,204 |   | $ | 0.676 |   |

 

***Preferred Stock.***  We are authorized to issue up to 5,000,000shares of preferred stock, par value $1 per share, with such terms,characteristics and designations as may be determined by the Board ofDirectors.  No such shares are issued andoutstanding.

 

***Shareholders’ Rights Plan.***** **OurShareholders’ Rights Plan (the Rights Plan) provides for the distribution ofone Right for each outstanding share of our Common Stock held of record as ofthe close of business on January 27, 1997 or that thereafter becomesoutstanding prior to the earlier of the final expiration date of the Rights orthe first date upon which the Rights become exercisable.  Each Right entitles the registered holder topurchase from us one one-hundredth of a share of Series A ParticipatingCumulative Preferred Stock, par value $0.01 per share, at a price of $40.00(the Purchase Price), subject to adjustment. The Rights are not exercisable until ten calendar days after a person orgroup (an Acquiring Person) buys or announces a tender offer for 15% or more ofour Common Stock, or if any person or group has acquired such an interest, theacquisition by that person or group of an additional 2% of our CommonStock.  In the event the Rights becomeexercisable, then each Right will entitle the holder to receive that number ofshares of Common Stock (or, under certain circumstances, an economicallyequivalent security or securities of the Company) having a market value equalto the Purchase Price.  If, after anyperson has become an Acquiring Person (other than through a tender offerapproved by qualifying members of the Board of Directors), we are involved in amerger or other business combination where we are not the survivingcorporation, or we sell 50% or more of our assets, operating income, or cash flow,then each Right will entitle the holder to purchase, for the Purchase Price,that number of shares of common or other capital stock of the acquiring entitywhich at the time of such transaction have a market value of twice the PurchasePrice.  Rights under this plan can beredeemed and certain amendments

 

F-20

----

 

tothis plan can be effected only with the approval of the Continuing Directors,which are defined in the Rights Plan as the current directors and any futuredirectors that are approved or recommended by Continuing Directors.  The Rights will expire on January 26,2007, unless extended, unless the Rights are earlier exchanged, or unless theRights are earlier redeemed by us in whole, but not in part, at a price of$0.001 per Right.

 

**13.  Supplemental Disclosure Information**

 

***SupplementalBalance Sheet Information.***  Components of accrued expenses and othercurrent liabilities are summarized as follows (in thousands):

 
| ** **                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|
| Accrued employee compensation  and benefits |       | $        | 5,578      |     | $          | 3,757 |   |
| Provision for  self-insured liabilities     |       | 3,275    |       | 3,785    |       |
| Accrued rent expense                        |       | 4,473    |       | 5,612    |       |
| Customer deposit  liability                 |       | 2,460    |       | 2,231    |       |
| Accrued interest  expense                   |       | 2,381    |       | 2,986    |       |
| Deferred revenue                            |       | 3,307    |       | 2,965    |       |
| Other                                       |       | 2,298    |       | 3,796    |       |
| Total                                       |       | $        | 23,772     |     | $          | 25,132 |   |

 

***Product Warranty Liability.***  The following table details the activity inour product warranty liabilities for 2004 and 2003.  This represents our liability for certainproduct warranty services provided free of charge (amounts in thousands):

 
| ** **                 | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|
| Beginning of year  balance |       | $        | 716        |     | $          | 1,120 |   |
| Charged to expense         |       | 5,596    |       | 6,846    |       |
| Paid                       |       | (5,892   | )          | (7,250   | )          |
| End of year balance        |       | $        | 420        |     | $          | 716 |   |

 

F-21

----

 

**14.  Selected Quarterly Financial Data (unaudited)**

 

Selected quarterlydata for our fiscal years ended January 1, 2005 and January 3, 2004is as follows (in thousands, exclusive of per share information):

 
| **Fiscal 2004**                                                                                         | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
|                                                                                                    |       |               |       |                |       |               |       |                |       |
| Total net revenue                                                                                       |       | $                  | 59,002     |                | $          | 57,897             |       | $                   | 56,988     |   | $ | 54,965 |   |
| Gross profit                                                                                            |       | $                  | 34,547     |                | $          | 31,774             |       | $                   | 32,558     |   | $ | 28,806 |   |
| Net earnings before  discontinued operations and cumulative effect of a change in accounting  principle |       | $                  | 2,153      |                | $          | 4,065              |       | $                   | 3,188      |   | $ | 717 |   |
| Income from  discontinued operations, net of taxes                                                      |       | $                  | 938        |                | $          | 713                |       | $                   | 586        |   | $ | 15 |   |
| Net earnings                                                                                            |       | $                  | 3,091      |                | $          | 4,778              |       | $                   | 3,774      |   | $ | 732 |   |
|                                                                                                    |       |               |       |                |       |               |       |                |       |
| Earnings per basic  share:                                                                              |       |               |       |                |       |               |       |                |       |
| Continuing operations                                                                                   |       | $                  | 0.43       |                | $          | 0.80               |       | $                   | 0.62       |   | $ | 0.14 |   |
| Discontinued operations                                                                                 |       | 0.18               |       | 0.14                |       | 0.11               |       |                |       |
| Net earnings per basic  share                                                                           |       | $                  | 0.61       |                | $          | 0.94               |       | $                   | 0.73       |   | $ | 0.14 |   |
| Earnings per diluted  share:                                                                            |       |               |       |                |       |               |       |                |       |
| Continuing operations                                                                                   |       | $                  | 0.39       |                | $          | 0.73               |       | $                   | 0.57       |   | $ | 0.13 |   |
| Discontinued operations                                                                                 |       | 0.17               |       | 0.13                |       | 0.10               |       |                |       |
| Net earnings per  diluted share                                                                         |       | $                  | 0.56       |                | $          | 0.86               |       | $                   | 0.67       |   | $ | 0.13 |   |

 
| **Fiscal 2003**                                                                                                | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
|                                                                                                           |       |               |       |                |       |               |       |                |       |
| Total net revenue                                                                                              |       | $                  | 52,381     |                | $          | 51,944             |       | $                   | 56,605     |   | $ | 55,784 |   |
| Gross profit                                                                                                   |       | $                  | 29,329     |                | $          | 28,645             |       | $                   | 30,537     |   | $ | 30,671 |   |
| Net earnings (loss)  before discontinued operations and cumulative effect of a change in  accounting principle |       | $                  | (2,189     | )                   | $          | (2,969             | )          | $                   | (421       | ) | $ | 279 |   |
| Income from  discontinued operations, net of taxes                                                             |       | $                  | 705        |                | $          | 248                |       | $                   | 777        |   | $ | 266 |   |
| Cumulative effect of a  change in accounting principle                                                         |       | $                  | (564       | )                   |       |               |       |                |       |   |
| Net earnings (loss)                                                                                            |       | $                  | (2,048     | )                   | $          | (2,721             | )          | $                   | 356        |   | $ | 545 |   |
|                                                                                                           |       |               |       |                |       |               |       |                |       |
| Earnings (loss) per  basic share:                                                                              |       |               |       |                |       |               |       |                |       |
| Continuing operations                                                                                          |       | $                  | (0.44      | )                   | $          | (0.59              | )          | $                   | (0.08      | ) | $ | 0.06 |   |
| Discontinued operations                                                                                        |       | 0.14               |       | 0.05                |       | 0.15               |       | 0.05                |       |
| Cumulative effect of a  change in accounting principle                                                         |       | (0.11              | )          |                |       |               |       |                |       |
| Net earnings (loss) per  basic share                                                                           |       | $                  | (0.41      | )                   | $          | (0.54              | )          | $                   | 0.07       |   | $ | 0.11 |   |
| Earnings (loss) per  diluted share:                                                                            |       |               |       |                |       |               |       |                |       |
| Continuing operations                                                                                          |       | $                  | (0.44      | )                   | $          | (0.59              | )          | $                   | (0.08      | ) | $ | 0.05 |   |
| Discontinued operations                                                                                        |       | 0.14               |       | 0.05                |       | 0.15               |       | 0.05                |       |
| Cumulative effect of a  change in accounting principle                                                         |       | (0.11              | )          |                |       |               |       |                |       |
| Net earnings (loss) per  diluted share                                                                         |       | $                  | (0.41      | )                   | $          | (0.54              | )          | $                   | 0.07       |   | $ | 0.10 |   |

 

F-22

----

 

**15.  Related Party Transactions**

 

On August 20,2004, we entered into a consulting agreement with Dr. Marc Nelson, a member ofour Board of Directors, under which Dr. Nelson will provide certain consultingservices with respect to our freestanding vision centers.  The Audit Committee of the Board of Directorshas approved this agreement, which contemplates that Dr. Nelson will provide upto 400 hours of such services through August 2005 at a rate of $150 perhour.  The expense incurred by theCompany under this agreement during 2004 was $6,975.

 

Nelson EyeAssociates, P.C., a professional corporation owned by Dr. Nelson, leases fromus eye examination offices and equipment in 10 of our vision centers.  This entity paid us $300,000 in rent forthese locations in each of 2004, 2003 and 2002.

 

We lease our St.Cloud facility from Mr. Myrel Neumann, a formermember of our Board of Directors through 2002. In that year, we paid Mr. Neumann approximately $80,000 in rent for thisfacility.

 

**16.  Commitments and Contingencies**

 

***Stock Appreciation Rights.***  Pursuant to the terms of our ManagementIncentive Plan (the “Incentive Plan”), 401,411 performance units were awardedto members of senior management on June 29, 2004.  The performance period expires on June 29,2007.  Each performance unit is payablein cash in an amount equal to the excess, if any, of the average market valueof a share of the Company’s common stock during the 20 consecutive trading daysending June 29, 2007 over the closing price of a share of the Company’scommon stock on June 29, 2004 ($2.30). During 2004, 8,105 of these performance units were cancelled leaving 393,306units outstanding at January 1, 2005. We recorded compensation expense of $349,000 during 2004 relating tothese units.  The expense was estimatedbased on the excess of the closing price of our common stock on January 1,2005 over the closing price of our common stock at June 29, 2004, and theportion of the performance period elapsed as of January 1, 2005.  The estimated expense of $349,000 is includedin Other Long Term Liabilities in the Condensed Consolidated Balance Sheet.

 

***Non-Cancelable Operating Lease andLicense Agreements.***** **We are required to payminimum and percentage license fees pursuant to certain commercial leases andpursuant to agreements with our host store companies.

 

Our headquartersin Lawrenceville, Georgia includes a distribution center and lenslaboratory.  The building is leasedthrough January 2009.  We paidapproximately $215,000 annually in rents for this facility in each of 2004,2003, and 2002.

 

Our lease foradministrative headquarters and an optical laboratory in St. Cloud, Minnesotaexpires in 2007.  Lease expense on thisfacility was approximately $80,000 per year in each of 2004, 2003, and 2002.

 

Aggregate futureminimum payments under all license and lease arrangements are as follows(amounts in thousands):

 
| **Fiscal Year**               | ** ** | **Operating  Leases** | ** ** |
|-------------------------------|------------|-----------------------|------------|
| 2005                          |       | $                     | 21,040     |   |
| 2006                          |       | 16,467                |       |
| 2007                          |       | 9,921                 |       |
| 2008                          |       | 5,451                 |       |
| 2009                          |       | 3,540                 |       |
| Thereafter                    |       | 6,344                 |       |
| Total minimum lease  payments |       | $                     | 62,763     |   |

 

Total rentalexpenses related to all cancelable and non-cancelable operating leases wereapproximately $30.8 million, $34.1 million and $34.0 million for 2004, 2003 and2002, respectively.  Total rental expenseincludes percentage rental payments in excess of minimum rent obligations ofapproximately $6.8 million, $8.0 million and $6.9 million for 2004, 2003 and2002, respectively.

 

***Legal Proceedings.******* **We are involved in certain litigation andclaims arising in the normal course of business.  In the opinion of management, the resolutionof these matters will not have a material adverse effect on our financialposition or results of operations.

 

**17.  Subsequent Events**

 

From January 1,2005 through March 22, 2005, we have closed seven Wal-Mart vision centersthat had sales of $4.7 million and store operating income of $1.1 millionduring 2004.

 

F-23

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**SCHEDULE II**

 

**NationalVision, Inc.**

**Valuationand Qualifying Accounts**

**Forthe years ended January 1, 2005 (Fiscal 2004), January 3, 2004(Fiscal 2003)**

**and****December 28, 2002 (Fiscal 2002)**

**(in thousands)**

** **
| ** **                                       | ** ** | **Additions**                      | ** ** | ** **                             | ** ** | ** **                      | ** ** |
|--------------------------------------------------|------------|------------------------------------|------------|----------------------------------------|------------|---------------------------------|------------|
| **Description**                                  | ** ** | **Balance at  Beginning  of Year** | ** ** | **Charged to  Costs and  Expenses(1)** | ** ** | **Charged  to Other  Accounts** | ** ** | **Deductions -  Write-Offs(1)** | ** ** | **Balance  at End  of Year** | ** ** |
|                                             |       |                               |       |                                   |       |                            |       |   |   |   |   |
| **2004**                                         |       |                               |       |                                   |       |                            |       |   |   |   |   |
| Allowance for  uncollectible accounts receivable |       | $                                  | 769        |                                   | $          | 1,690                           |       | $ | — |   | $ | 2,036 |   | $ | 423 |   |
|                                             |       |                               |       |                                   |       |                            |       |   |   |   |   |
| **2003**                                         |       |                               |       |                                   |       |                            |       |   |   |   |   |
| Allowance for  uncollectible accounts receivable |       | $                                  | 1,030      |                                   | $          | 1,772                           |       | $ | — |   | $ | 2,033 |   | $ | 769 |   |
|                                             |       |                               |       |                                   |       |                            |       |   |   |   |   |
| **2002**                                         |       |                               |       |                                   |       |                            |       |   |   |   |   |
| Allowance for  uncollectible accounts receivable |       | $                                  | 2,375      |                                   | $          | 2,699                           |       | $ | — |   | $ | 4,044 |   | $ | 1,030 |   |

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(1)                                  The2003 and 2002 amounts have been adjusted to report on a gross basis to reflecttotal charges to expense and write-offs for those years.  Amounts were previously reported on a net basis.

 

S-1

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**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities Exchange Actof 1934, the registrant has duly caused this report to be signed on its behalfby the undersigned, thereunto duly authorized.

 

 
|                 | NATIONAL VISION,  INC.                 |
|----------------------|----------------------------------------|
|                 |                                   |
|                 | By:                                    | /s/Reade  Fahs |   |
| March 25,  2005 | President  and Chief Executive Officer |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below on March 10, 2005 by the following persons on behalf ofthe registrant, in the capacities indicated.

 
| **Signature**                  | ** ** | **Title** |
|--------------------------------|------------|-----------|
|                           |       |      |
| By: /s/Reade  Fahs        |       |      | Chief Executive  Officer and President |
| Reade  Fahs               |       |      |
|                           |       |      |
| By: /s/Paul A. Criscillis, Jr. |       |      | Senior Vice  President and Chief Financial Officer |
| Paul A. Criscillis, Jr.        |       |      |
|                           |       |      |
| By: /s/Robert E.  Schnelle     |       |      | Vice President,  Principal Accounting Officer |
| Robert E. Schnelle             |       |      |
|                           |       |      |
| By: /s/Robert Floum            |       |      | Director |
| Robert Floum                   |       |      |
|                           |       |      |
| By: /s/James W.  Krause        |       |      | Director |
| James W. Krause                |       |      |
|                           |       |      |
| By: /s/Marc B.  Nelson         |       |      | Director |
| Marc B. Nelson                 |       |      |
|                           |       |      |
| By: /s/Jeffrey  Snow           |       |      | Director |
| Jeffrey Snow                   |       |      |
|                           |       |      |
| By: /s/Peter T. Socha          |       |      | Director |
| Peter T. Socha                 |       |      |
|                                |            |           |  |  |  |  |  |  |  |

 

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